The first thing to notice in ... is that dealers are a counterparty to almost every transaction (they participate in about 98% of all traded volume). This means that dealers are the primary source of liquidity in this market as they facilitate the vast proportion of trades.Not too big to fail banks like J.P. Morgan-Chase!
The second thing to notice is that the inter-dealer segment of the market accounts for about two thirds (64%) of all activity. This highlights the intermediation role that dealers play....The quintessential middleman role. How'd they do?;
Figure 1 [in their spiffy color graphs] shows that, although aggregate daily volume in the UK CDS market dropped during our sample period from about €2 billion in 2007–08 to about €1 billion after 2009, the market never really shut down. Strikingly, volumes shot up in the wake of Lehman’s default; this is surprising given that Lehman Brothers was a major dealer in the CDS market. It thus appears that the market held up well against concerns about counterparty risk. ....Figure 2 shows that dealers continued to intermediate between ultimate CDS buyers and sellers throughout and at the peak of the financial crisis.Nor do the economists find abnormal price spreads; it appears that the collateral and netting arrangements in place, by and large, mitigated counterparty credit risk concerns in the CDS market during this period of market stress.
They do the math;
Figure 4 shows that there are relatively small variations in our trading cost measure across inter-dealer and dealer to end-user trades. While the dispersion of transaction prices around par spreads is generally lower for inter-dealer trades, the differences are not economically significant – the medians of the relative distances are no more than 1% apart from each other across breakdowns.The very lightly regulated, over-the-counter market worked;
This may seem puzzling, but one potential explanation is that most CDS market participants are sophisticated and presumably well informed; there are no retail investors in this market.Not puzzling at all, to those who don't get their economics from hysterics.