If you have been following the credit crisis in any detail, you might have heard that the 53 trillion CDS market threatens to cause cascading bank failures that would bring down the financial system. What you might not have heard is the other dire threat posed by the CDS market: drastically higher borrowing costs on corporate debt.

Most investors are not aware that, over the years, CDS were leveraged up and packaged into investment vehicles. Since these leveraged investment vehicles sold an enormous amount of insurance, the premiums for CDS drooped sharply, making corporate debt seem safer and lowering interest rates. In effect, the process of building up the 53 trillion CDS market created an era of artificially easy credit. Unfortunately, the pendulum is now swinging in the other direction, and the pain has just begun.

After stalling out earlier this year, the money inflows have now reversed, and trillions of dollars have begun to unleverage and flow out of the CDS market. CDS investment vehicles are having to buy back the insurance they sold to close out their positions, which is making the premiums for insuring corporate debt soar and pushing up interest rates. As the long process of deleveraging in the CDS market continues, borrowing costs will keep rising higher, creating a period of artificially tight credit.

The implications of America switching from a period of easy credit to tight credit are huge, especially with the popularity of leveraging up to fund acquisitions and buybacks in recent years. Corporations like GE who went on a borrowing binge to buy back their overvalued stocks are now having to roll over their debt significantly higher interest rates. With revenue plummeting as consumer spending is grinds to a halt, it is doubtful the GEs of the world will be able to survive paying double digit interest on their debt.