If a CDS is sold (say, by Lehman to a bond investor), and Lehman resold it, and on and on say, 10 times, they are selling two things: (1) the insurance obligation and (2) the premiums or cash flow for assuming the risk of default.

Let’s say this cash flow is 5% of the face value of the bond (the actual number doesn’t matter), per year.

If Lehman sells a CDS to Goldman, they are selling both the risk and the risk premium, right? Then Goldman sells to Morgan, etc….and here is my question:

How do we get to a 45 trillion market? The income premium has not changed. It’s still at 5%. What has happened is a simple income transfer, from Lehman to Goldman to Morgan, to….

The original bond purchaser will have a harder time finding out exactly who his insurer is. But the premium he paid Lehman hasn’t changed (5%)….

The only way I can see to get to a 45 trillion market in CDS derivatives is to inflate the price. But no one would do that beyond the cash flow the insurance policy would pay. Correct?

What am I missing?

Thanks in advance if you can clear this up for me.

S.