Above my pay grade here, but as stupid as this is I imagine a lot of the institutions buying credit default swaps knew they weren't really buying insurance but the appearance of insurance. It allowed them to pretend that whatever shitty assets they held weren't really so shitty because they were insured after all. Even though they really weren't.
Taking out insurance on sovereign debt is kind of like taking out flood insurance on all the coastal properties in a hurricane zone, if flood insurance had no regulation whatsoever. When the big one comes no one is really going to be able to pay.
