Bloomberg News has an important report on how sovereign defaults in Europe could infect the U.S. banking system via ye olde credit-default swap market.

Yalman Onaran reports that the too-big-to-fail U.S. banks are ratcheting up their exposure to a collapse of the PIIGS by selling credit-default swaps to investors trying to insure against a default. Such insurance (most of which is CDS issued by the top U.S. banks) rose to more than half a trillion dollars by this summer, up nearly 20 percent in six months.

The banks say that they’ve hedged their bets and taken on collateral. But we heard similar things back in 2008. Then AIG happened:

Similar hedging strategies almost failed in 2008 when American International Group Inc. couldn’t pay insurance on mortgage debt. While banks that sold protection on European sovereign debt have so far bet the right way, a plan announced yesterday by Greek Prime Minister George Papandreou to hold a referendum on the latest bailout package sent markets reeling and cast doubt on the ability of his country to avert default.

In other words: JPMorgan Chase, Goldman Sachs, and the like are betting that Europe thinks the consequences of triggering CDS would be so bad that they won’t consider allowing a hard default. So the banks are writing a lot more CDS on the likelihood of this indirect bailout, which has the side benefit of making the potential contagion from a default that much worse, which makes it less likely that Europe will allow a default. Moral hazard, indeed.

There’s no indication that there’s an AIG out there that’s the ultimate dumping ground for the risk taken on here, but there wasn’t back in 2008, either. Bloomberg notes that banks don’t have to disclose their counterparties.

JPMorgan CEO Jamie Dimon, 55, said last month that the New York-based bank hedges its exposure to European sovereign debt through contracts with lenders in other countries, including Germany and France.

You can see how this might be a problem, right? Insure people against European catastrophe and then insure your insurance with European banks. What could go wrong? Bloomberg says the Dexia bailout was similar to the AIG backdoor bailout:

The bailout of Dexia SA by Belgium and France last month resembled AIG’s rescue…

The two countries agreed to aid Dexia on Oct. 9, assuring creditors — including holders of CDS and other derivatives counterparties — they would be paid in full, the same way AIG’s were after the U.S. takeover. Goldman Sachs and Morgan Stanley (MS) were among the lender’s biggest trading partners, the New York Times reported on Oct. 23, citing people it didn’t identify.

Meantime, the banks are reporting their exposure is far lower than it ultimately may be due to counterparty risk, Bloomberg reports.

As for Greece, one of the most glaring aspects of Eurozone rescue plans has been how they’re designed to avoid triggering CDS:

European leaders are doing everything they can not to trigger the default clauses in CDS contracts to avoid putting the banking system at risk.

How bizarre is the CDS market? Here you have an insurance product ostensibly designed to disperse risk and make the system safer. But you can’t actually use this insurance, which banks nevertheless make a fortune selling, because it’s considered so risky that authorities will do everything they can to avoid activating it.

Onaran gets at the ultimate problem with this quote from a small investment bank:

“Risk isn’t going to evaporate through these trades,” Cannon said. “The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?”

I’d like to think that banks have at least learned some lessons in the last four years. But I wouldn’t insure a bet on it.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.