You put your own reputation on the line when you write a letter of recommendation. If you feel you do not know the person well enough, or they are somebody you cannot in good conscience recommend, decline their request.
Do graduate schools care if letters are confidential or not? In general, graduate programs prefer confidential letters. Admissions officials say that it displays more confidence on the part of the applicant if letters are "confidential" (meaning you, the applicant cannot see the letter). The Letter Service is required to indicate on the letter if it is confidential or non-confidential.