[mhneu]

many, many people making good-faith, rational decisions which in hindsight proved foolish.

Rational, yes, but rational only in the sense of "the market can stay irrational longer than you can stay liquid".

My experience is many MBS and finance people, during 2003-2008, knew that a ton of debt was garbage, that LTCM's blowup in 1998 showed massive structural weakness that was never repaired, and that a crash was going to come SOMETIME.

But the problem is that the rational decision in such a market is to keep investing and making money on the irrational rise, because no one knows when the crash will come or how bad it will be. It's actually rational to keep buying trash debt when the crash timing is unpredictable.

In the end, the finance people were actually correct to keep buying –– the gov't (that is, me you and every US taxpayer) bailed them out, and most of the traders did come out ahead after a bit of time.

[JumpCrisscross]

> knew that a ton of debt was garbage

The GFC was not a crisis of credit or trash assets. It was one of liquidity and hidden interconnections. (In America.)

If you look at how those supposedly-toxic CDOs actually paid out, including the CDOs squared and synthetics and whatnot, the ones rated AAA, the ratings agencies were--by and large--on the money [1]. The AAA tranches paid out AAA cash streams.

The problem was market participants took this to mean they'd behave like other AAA assets in all capacities. Including liquidity. That was a bad assumption. When people are scared, they'll trade for Treasuries. Not the thing that by all reason should pay out like a Treasury, and in fact, with the benefit of hindsight, did.

To the extent there was high hooliganery afoot, it was around e.g. CDSs written by non-bank actors, e.g. AIG. Which was a result of the liquidity problem described above.

[1] There is an obvious asterisk here in the endogeneity of the bailouts and these assets' performance. But given the pattern holds across borders and industries, irrespective of bailout intensity, the hypothesis that tranching works carries more weight.

[pgwhalen]

Where would I find data about “toxic assets” from the crisis and how they actually fared? I’m very curious about the details.

[JackFr]

I’m going to disagree, and to some extent I think you prefer the simple narrative with bankers as villains.

I worked on a prop trading desk with some housing bears, who made some significant gains with shorts. While they understood that certain markets were overheated, I don’t think any of them suspected the breadth and depth of the crash that was coming. While their models were better than the other guys, in the end they were really wrong too. Just less wrong then the guys who went long.