[DanielBMarkham]

Wow. This is 180 degrees away from the mainstream narrative of how the crisis developed.

I'm not trying to bait you or argue, but do you have any links? I'd be interested in some supporting documentation for your claim.

[mcphilip]

It's 180 degrees against the mainstream narrative because it is a ridiculous oversimplification of the crises and misleading in its claims about OTC derivatives. For a serious look into the complex causes of the crisis, I recommend Econned by Yves Smith [1].

My (weak) take on the crisis TL;DR:

Prolonged, low interest rates set by the Fed in the aftermath of the dotcom bubble led to investors looking for better returns outside of AAA bonds. With the introduction of CDOs, investors were given the option of purchasing AAA rated tranches that paid better rates than bonds. The interest in CDOs exploded, leading to weakening of lending standards allowing the housing boom to really take off. From there it gets much more complex, but ultimately the maths on CDOs didn't work out and everything came crashing down.

[1]http://www.amazon.com/gp/aw/d/0230114563

[onebaddude]

>I'd be interested in some supporting documentation for your claim.

No offense, but it starts with having an understanding of what a derivative is and how they are used. There is nothing sinister about them in any fashion, nor were they the "cause" of anything. The mainstream, as usual, has it wrong.

At the base level, excessive risk was the problem, and because derivatives employ leverage, that risk is amplified.

[DanielBMarkham]

I'm going to have to categorize that as being non-responsive.

Let's assume I know what a derivative is. We can go from there. The specific accusation made in the mainstream press was that by the time the instruments were sliced and diced a dozen times, risk was not made clearly visible to derivative purchasers, and that the buying and selling of derivatives got way ahead of the banks' ability to track the risk inside of them. At high leverages, it became such that being wrong by just a few percentage points could mean financial disaster. The guarantee that Freddie and Fannie made contributed to a general feeling that the market was mostly protected from huge systemic risks, when that wasn't the case at all.

[yummyfajitas]

Consider a plain vanilla housing package. Payoff = homeowner_payments.sum().

Now consider the least risky tranch of a CDO. Payoff = min(homeowner_payments.sum(), 0.7 x MAX_HOMEOWNER_PAYMENT).

Is it unclear that if homeowner_payments.sum() goes way down, you lose money? Of course not. For every derivative on the market, computing your gains/losses given a specific scenario is straightforward.

The only difficulty is computing the probability of each scenario, but derivatives don't change that calculation at all.

[tedunangst]

You are generalizing from one specific derivative to all derivatives.