How the Subprime Mortgage Crisis Happened

I've often thought that understanding so-called "High Finance" must be difficult. People made much money there: so they had to be very clever. And they are clever: just not in quite the way I imagined (to be fair to myself: I never spent much time thinking about this. I just had a vague notion.) What is true about high finance - and even the financial industry broadly - is that they are “middle men” who spend much of their time “advising” adults what to do with their own money. I intend the scare quotes there. The incentives for some financial people - especially in big investment banks - is to make lots of money and this can involve deception of their own customers. The reasons for this will become clear - but in short, because investment bankers take a percentage of the money they handle and the percentage grows with more risky investments, they can gamble with money not theirs to make large profits part of which will be theirs and yet never risk any personal losses. This is a real liability. All potential losses are on the side of the investor only. Investors with investment banks, it would seem, frequently don’t take time to actually understand the so-called “products” they invest in. And why? Because they are told that the “product” has a very good rating - given to it by an upstanding, objective “ratings agency”. We will come to see that this too is false.

It was once the case that big investment banks like "Goldman Sachs", "Morgan Stanley", "JP Morgan Chase" and so on were partnerships. This is crucial. It meant they invested their own money in this or that project. So they were exceedingly careful with their own wealth. But then something happened: the investment banks became public companies and this lead to them (namely the employees of these investment banks) using the money of other people to invest in projects. So they had less concern about how sound the investment was and more concern with how high the return might be (in other words: undertaking more risky investment was more profitable to the employee of the investment bank - who wasn't taking on the financial risk, as the investor did). A lovely, almost quaint paper published in 2005 explains some consequences of this further here.  (You can ignore the big mathematical formulas there and concentrate on the main explanations which are placed into bullet points. My eye was drawn to the "free rider problem" which is essentially how employees in investment banks, who are not partners, but have control over vast sums of money, have very little incentive not to take huge risks with the money of the firm (and hence investors). If even the very worst happens (like the firm collapses) then because there is no actual capital, really, in the firm, everyone loses except for the employee who makes the biggest bets because they get to keep their own personal wealth (it's protected, just like almost any employee's wealth or personal bank account would be if the company fails).

Before I begin my main explanation of the conditions under which the 2008 financial crisis began; a final assertion. Terminology used in the high finance sector is cumbersome. It is deliberately opaque. That is to say: the words used are complicated to hide the fact that there is very little content behind them. This has an analogue in an area of “philosophy” known as “postmodernism”. (Again, scare quotes intended!). There, academics who have given other academics broadly a bad name among some sectors of the community (they are the people who truly deserve the derision of the “ivory tower” insult) write paper after paper that cannot really be analyzed...because they have nothing to say. Richard Dawkins explains the phenomenon here: http://www.physics.nyu.edu/sokal/dawkins.html in one of my favorite book reviews of all time. The point there is: some “experts” in the social sciences deliberately hide the fact they don’t know much and have little to say by inventing ever bigger words to disguise their ignorance. In finance something similar is true: language invented to deceive. A wonderful little blog here http://www.interfluidity.com/v2/2669.html explains this phenomena with the author writing “Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk.”. In other words, investment bankers (especially) know that rich investors don’t have time to devote to carefully checking the details and so hire an apparent “expert” (the banker) who spins them a tail with fancy jargon using terms like AAA rated Collateralized Debt Obligations which are a form of Mortgage Backed Security and told “It’s basically as secure as a government bond, but with a higher return”. Now who is the investor to complain? The investment banker is the expert. Not only that, thinks the rich investor, but I know enough about finance to know that a AAA rating is very secure indeed. The best.

The opacity of the language used and financial "instruments" invented by investment banks serves a dual purpose - not only to cast shadows over the investment products so that investors cannot clearly see what they are actually investing in, but also, as Michael Lewis points out in his book, to disguise from auditing firms the amount of capital, and potential losses investment banks have on their books and what the actual practices are of the investment bankers. Lewis tells the tale of an accountant who worked for a large accounting firm attempting to find out why investment bankers were making what seemed to him to be risky bets and answers were either not given, provided using jargon so complicated as to be impenetrable or simply told by his superiors to, essentially, not ask so many questions. This is how accountants who were auditing investment banks were being treated. There was no transparency. And there continues to be little transparency, it would seem.

Of course the investor, as much as an accountant, should not ever rely on trust - either of the "expert" banker or a ratings agency. If you have a large amount of money, or small you should be very careful what you do with it. Trust should not feature in your decision making. This is exactly like meeting a man on the street outside of a casino who says “I can invest your money for you and get you a big return. It will only cost you $1 on every $100 you invest with me. If you win, I’ll take 1% of your profits.” (Meantime, it turns out he’s also getting an extra percentage from the Casino and if you lose your money he gets a percentage of those losses as well). This would obviously be fraud. Even if the man on the street outside the casino was in a suit and had a degree in mathematics and claimed he had devised a system to win at roulette every single time. The responsibility here is on all parties to not lie, and not trust one another. Trust is often claimed as a virtue: it isn't. That too is a lie we have sold ourselves. What you need instead is a good explanation of why a person behaves a certain way towards you. If someone genuinely loves you, then "trust" is shorthand for: I believe they will treat me well because we care for each other. If the doctor tells you the test results are negative and shows you the print-out, it's not trust at that point: your (hopefully ongoing) relationship with a person with expertise has shown you a proxy for evidence. And if you wanted you could get a completely independent second opinion. You guess that the error checking that's gone on is of a high standard. But in finance, it seems difficult to get that second opinion, largely, and your ability to even check the error-correcting mechanisms is kept behind a firewall of systems and practices designed to confuse rather than make clear. Although Michael Lewis' book "The Big Short" is an example of how the majority of the finance world was wrong, and there did exist a second opinion - but it was almost impossible to find if you were an investor.

So my concern here, in the first instance, is rich investors. Now by this I do not mean simply “wealthy individuals” (although they are a subset of the rich investors) - I mean also large corporations and, for example, other banks and superannuation funds where the majority of people in the developed world have their money. Those organizations (and by proxy the people with their money invested with them) are in a very important way central to the functioning of a peaceful society that is striving to make progress. Those organizations turn to yet other organizations (the investment banks) for a place, and for advice about where, to put their money. Sometimes banks and superannuation funds buy stocks, sometimes government bonds. And sometimes they buy loans: specifically, in this case: sometimes home mortgages. But I get ahead of myself.  Let me begin the main part of my explanation:

This information comes largely from the book “The Big Short” by Michael Lewis. Additional information comes from podcasts (search Apple's Podcasts for Michael Lewis) and interviews with Michael Lewis in other places, Encyclopedia searches and other articles as referenced throughout. I’d love to know if and where I’m mistaken about any of this. I did read more widely, and I did watch some other financial "experts" speak about the crisis but for reasons I explain at the very end of my piece here, I found that those people misdiagnosed and, it would seem, continue to either misunderstand or lie about both the proximate and ultimate causes of the 2008 global financial crisis. Alternative explanations to those provided here tend not to implicate investment banks and bad lending practices - but other factors. And they suffer from the same flaw: correlating certain events with other events in an attempt to force a person to see a causal link where none exists. I explain that error at the end. I have, therefore, heard no other actual causally valid theory that explains the crisis as the one I am about to present here, taken from Lewis.

So, my aim here was to take some weeks to really try to understand what “Wall Street” investment outside the buying of stock in companies is about. What is “high finance”? It seemed very complicated. And, at root, I admit I really didn’t understand why the global financial crisis of 2008 happened. I knew the term “sub-prime mortgage” (and even thought I knew what it meant [it meant lending to people who probably couldn’t pay the loan back]) but I thought my understanding of that had to be in error. Surely banks wouldn’t lend to people they knew - or even guessed - would not pay back?

So here’s what I learned:

Big banks in the United States were, for some time, making less money from loaning to borrowers than they were selling those loans to (even bigger!) big investment banks - including, sometimes to each other. So, for example, say you’ve got a rather small bank in some town in some state in America. They offer a loan of like 4% interest to borrowers. The rates are so low because the government wants people to invest in housing as an economic “stimulus”. So the loan rate is low because the Federal Rate is low. The bank adds little, if anything, onto the Federal Rate. But where they make money on the loan is selling the loan to a bigger investment bank (like, say Goldman Sachs). What Goldman Sachs does is buy lots and lots of these loans from many many banks. I'll just continue to use Goldman Sachs because they are the biggest of the big investment banks in the USA. Just prior to the crisis, there was a proliferation of small "sub-prime" lenders in the United States. The reasons for this are somewhat beyond the scope of my treatment here, but suffice it to say there was a government drive to fuel investment in housing. The Federal Government facilitated, and backed, this policy by partnering with huge government backed mortgage lenders like, for example "Fannie Mae" (this is the nickname given to Federal National Mortgage Association). This so-called "Government Sponsored Enterprise" provided funds for lots of small lenders - credit unions, banks and other "mortgage houses" to lend money to people to buy houses. So this is one thing to keep in mind: there was a great incentive for private lenders ("banks" both small and large) to offer loans to people. But ask: what happens once the pool of people with good credit begins to dry up? Do you continue to offer them more loans at ever cheaper rates or perhaps even offer loans to people with slightly worse credit? And then slightly worse credit that that? We will come to this too.

Investment Banks pile loans from many other banks together into something called a “”Collateralized debt obligation” (or CDO). The CDO is made up of lots of loans from lots of borrowers -so it’s worth literally billions of dollars. But some loans are a better bet than other loans. Some loans are given to rich borrowers with better jobs in good health with good credit who are likely able to pay them back. Others are “sub prime” - people with part-time jobs (or no jobs!), perhaps with a serious medical condition and perhaps with few or even no assets (or whatever other factors might otherwise disqualify a person from getting a loan under normal lending criteria). How people with bad credit get big loans for houses is a whole other  story in itself, which I will just sketch here far too briefly to do justice to; It seems, from my reading it was a mixture of greed and silliness on the part of the borrowers (they should have known they could not pay back a million dollar loan with a part time job that pays only $12 an hour) and dishonesty from some banks (they lied to their customers and told them they paid very very low interest and indeed paid only the interest on the loan (never the principal!) and could “refinance” (borrow more money if it ever got hard for them! And by the way: the banks did refinance if the borrowers couldn’t pay. Any money paid off on your house could be borrowed back if you couldn’t make a payment this or that month. Sometimes banks just offered people the ability to refinance to buy more properties, or a car, or whatever else they might want. Michael Lewis provides a number of little examples where people on low incomes owned multiple properties. Think: a gardener earning a small hourly rate with 3 mortgages. A home and a couple of "investment properties". This silliness can occur only when both the borrower and lender are willfully ignorant of the real circumstances of the borrower. One reason this type of lending continued for so long was because those doing the lending were actually operating on a false assumption: that they were selling all the risk in the loans to the bigger investment banks when the CDOs were created. But this was false. The risk remained in the entire system.

So the investment banks made piles of CDOs. Some of the loans in them were better than others. They ranked the loans. So think of a skyscraper where - at the top - are the reliable loans that will get paid back - and at the bottom - the bad loans that people must have known were terrible loans to people who could not pay back.

The argument is this: spread across the whole CDO - thousands of loans (it was hard to find an exact number - if anyone knows, let me know) - the risk that the whole thing would go bust was close to zero. I mean: lots of those loans are actually good loans to reliable borrowers.

So in come organizations called “Ratings Agencies”. A rating agency looks at the CDO and decides if it’s a good investment or not. At least that the theory. In reality what happens is, long story short - they evaluate the risk based on arguments from the investment banks (not their own investigations!) and give the CDOs the highest possible rating: AAA. This means the CDOs are like government bonds. Investors don’t think twice about investing in them. The interest return (or yield) is low for AAA things precisely because the risk is comparatively low compared to buying, for example, so called- "junk bonds" (which can produce a high return if you don't lose all your money if some company doesn't collapse). If you want a high return: you should go for low rated investments (C, or B or BB or whatever...) but you might lose all your money if the investment fails. It’s gambling. Except the odds aren’t well constrained (unlike at a casino where you can actually determine the odds).

So the ratings agencies (Moody’s, Standard and Poor's, and Fitch) - people think of them like a government organisation. They have some sort of special government license to do what they do. So they seem like they have expertise and authority. They do. But they are more like computer game magazine reviewers. Or movie reviewers. Just because some newspaper critic says a movie is 4 stars doesn’t mean you will enjoy it. Or that it’s objectively good or something like that.

Just because a ratings agency says a CDO is AAA doesn’t mean it safe! The ratings agency themselves argued this when they testified before the USA government once all this chaos happened. They were basically like movie critics, was their argument: their rating had no objective meaning. It was just mere opinion.

But the ratings AAA through to C meant something! (For stuff on ratings see here: https://en.wikipedia.org/wiki/Credit_rating )

Yet in a sense the AAA ones were objectively better than the Bs and Cs for the same reason the loans at the top tier of the CDO were better than the bottom ones: the borrowers had more assets and so if they fell on hard times you could at least get money back. The bottom: no assets and so if the ability to pay failed - there was no capital to call on.

So next: there were some loans so odious that the investment banks were wary of them being packaged into CDOs. But they were packaged up anyway, because it was so profitable to sell these CDOs. And once all the good ones were sold...well, why kill a cash cow? All involved couldn't believe anything truly terrible could happen. Or maybe they did? It's hard to know at this point if it was ignorance or genuine fraud. So CDOs were created entirely with sub-prime mortgages. Entirely. However, sub-prime mortgage backed CDOs could not possibly be AAA rated like the others, right? Well they were! The investment banks taught (read told) the ratings agencies what rating to give the CDOs. The ratings agencies made their money based on how many "products" they rated. If they gave the product (like a CDO) a bad rating then the investment bank might not ask them to rate them anymore. And there were only 3 agencies. So if you were the one agency who rated a CDO low, while the others went high you might lose face. In reality it would have been the other way around. But no one seems to have been thinking critically much at all. The argument made at the time was that sub-prime mortgage backed security CDOs had the "risk spread". It was inconceivable that they'd all fail all at one time. The loans might come from all across the USA. So it’s hard to think everyone from Southern Florida to Northern California at the same time will lose their jobs (or whatever) and be unable to make their repayments. Or even not everyone but just large numbers of people. So these CDOs - made up of really bad sub prime loans - were nonetheless branded AAA.

And for years they behaved like AAA bonds. Because anytime someone couldn’t pay their loan - they “refinanced” - just borrowed against the money already paid back into their expensive house.

This all failed when - in the fine print of the loan contract (or not so fine - but people were a mixture of deceived, gullible and greedy) the interest rate went up. A lot. To like 8%. So like a 2-fold increase.  Some people started at like a 2% "teaser" rate before it jumped by a factor of 4 to 8%. If you are told “you only need to make payments on the interest of this loan not the principle and that amounts (today) to $400 a month that seems okay. Indeed easy maybe. But in 2 years if the rate jumps 4 times then that $400 becomes $1600 and you are well out of your league. But then the bank says: Well for 2 years you have paid money back into your house - so lets use that equity to borrow a new big loan - say $20,000 and keep you going and you think: ok (nervously, I guess). But it keeps you going. And the cycle continues. But clearly: not indefinitely. And a point comes where you can’t pay it back because there is no equity at all left in your home. So you have to sell your house. But the house is worth *much less* now than all the money you borrowed.  So the only option is for the back to repossess it. And they do.

But they can’t sell it. So now it’s a loss for them (banks aren’t in the real estate business! And they've lent the borrower so much money over this time that the loans might total $1.1 Million and the house has a worth of like $500,000 at best). And the real estate people are like: I’ll take it off your hands: for a *third* what the original cost was (they owe nothing to the banks!)).

So this started to happen. And yet loans continued to be made all the while in the almost-Ponzi-scheme like fashion where those unable to pay at all were just offered new loans. But eventually the money truly does dry up and the original lenders stopped making payments to the banks and the banks were holding onto houses they could not sell (agents were wising up and realising the houses were worth very little indeed because there was no longer any demand at all - all potential buyers (and hence borrowers) were gone.

Which means the loan payments that went to the banks then the onto the investment banks dried up. Which means people who invested with Goldman Sachs and so forth didn’t get paid. But there is some organization (like a superannuation fund) or even just some rich individual relying on their dividend in the bond (their share of the mortgage backed security - the CDO) being paid regularly. Like relying on it - to keep their business running! Without the money from their “AAA” rated investment - employees (or retirees) don’t get paid. So they demand their money.

But it turns out the investment banks - Goldman Sachs and so on - don’t actually have any real assets. Nothing they can sell. And no real cash. They are not like "normal" banks or other organisations. Normal banks have cash in reserve and indeed now in Australia and the USA (the two countries I looked into) the governments require banks - both big and small - to keep significant amounts of cash on hand to cover any potential "crises" or other downturns when people are unable to pay their loans back. This serves to ensure there's enough money floating around (for example: the ATMs are stocked up) to keep businesses and individuals going. Other organizations have capital like, well: their products and produce and gadgets and property, as well as perhaps, stock in other companies with the same. But investment banks? They have very little property and almost no cash, it turns out (but this was far from obvious at the time. People just trusted that these huge investment banks not only knew what they were doing but must have been extremely wealthy organizations. But they were not. They did not have much capital at all. What do they have then?

What they have are employees. And those employees individually have (sort of!) lots of money - like each has millions or tens of millions or in the case of the top executives - hundreds of millions or even billions - but it’s no where near enough to cover all the money being called in. And besides; they are just employees - their own personal wealth is technically not the wealth of the company anymore than the personal bank account of your local supermarket store checkout person is owned by the supermarket.

So we have a huge problem now. The sub prime loans can’t be paid back. And this happens across the country as the rates go up, and other little levers unfortunately move in a direction that causes housing prices to fall and people to lose jobs. But basically the loans can't be paid back as the rates have gone up and the payments increase. And the rates have to go up: because otherwise the loan is actually a loss because the original rates offered by the banks are too low to be profitable (they are called “teaser rates” and that term means what it says!).

So the USA government lowers interest rates. But they get as low as 0%. So to borrow from the government costs nothing, but that doesn't help because no bank can borrow anymore as they owe money to too many people. Borrowing yet more in order to keep cash flowing isn't a solution for them, as banks, because then they would owe yet more money and be in yet more debt.

So it turns out this all is not too difficult to understand. But at the time it would have been because the terminology and ratings systems and so forth were made - it seems deliberately - opaque so that innocent investors did not know the risk when they invested with big banks who claimed expertise in this stuff but were actually lying or incompetent. And the ratings agencies who pretended at objectively were also lying or incompetent. And other people like auditors who should have picked up the black hole at the heart of these big investment banks who were betting that sub-prime CDOs wouldn't fail - were being diverted from actually looking deep into the books. Because those books were just filled with such complex sounding and looking "instruments" in a smoke and mirrors type fashion that there was the illusion of security, where there was none.

Long story short: in the end in order to “keep the economy functioning” the USA federal government paid the investment banks and other banks to keep on functioning so that all original investors could be paid. That’s kinda okay. But the money was given to the banks with no (or few) conditions. So the employees who made the mess were awarded bonuses by their firms - CEOs and so on paid themselves and those under them hundreds of millions of dollars in total. And became even more rich. And more or less remained in their positions (there were a few prominent exceptions: scapegoats offered to the media and government as causes for the disaster. But these few individuals were not really the cause. It was the system. And most of the individuals involved were actually rewarded. So, for example, Howie Hubler
of Morgan Stanley lost more money than any individual ever in the history of the world ($9 billion traded on sub prime CDOs. For this awful mistake he was provided with a bonus of $10 million and allowed to rather discretely leave his company.) But I must emphasize - as much as individuals made off with the money, really the system was the cause. And rewarding loss like this is a terrible incentive, that still seems to be in place. This system is more or less in tact. It’s important to realize that most of the big loans given by the government to large financial institutions have been paid back (with interest) - see here: https://projects.propublica.org/bailout/list but that too is not really the issue. The issue is the systemic failure which, it seems, could happen again. Errors can (and will) always happen but the error correction that should have happened this time around did not. Once a particular error is found, it should be corrected, not rewarded. The vast majority of the people in the financial sector who created the mess were rewarded richly for it, allowed to keep their jobs and, it would appear, not change their theories because they had no incentive to (again, Howie Hubler did not keep his job - but that can be seen as scapegoating. All the other people who lost, as a collective far more than him, are, more or less, still in their jobs).

And so rich investors are remain largely blind to what investment bankers do with their money and the bankers have no incentive *not to be careful* about how they invest it because they will earn large sums of income regardless of profit or loss. So they can take ever bigger risks while producing nothing at all themselves.

We don’t know if bad loans are not still being made. And some people did not lose their homes but came very close. They barely make payments and scrape by. Their loans are still "subprime". And banks need to keep lending - so they do. And CDOs are still being sold to organisations. And they might not be reliable because although they’ve been filled by USA federal money (and keep being refilled) the pot is not infinitely deep. And investment bankers continue to siphon off millions (or in total billions) of dollars to pay themselves - a very very small number of people. And this is not to actually produce capital as such. People are rewarded not for creating ever better widgets or more efficient technology, cures, knowledge and so on: but instead just act kind of like a leech between investment and actual capital. Leech is a strong word: these people ostensibly provide a service to investors. But they are middle men between buyers and sellers and what the value of the service thus provided between the transactions occurring between buyers and sellers does not seem to be worth the vast sums these people make. Indeed the opposite: it is the middle men who are dampening growth in the market.

Capitalism is not the problem, I want to make clear: deception, fraud and a lack of transparency seems to be. Investment banks are there to ostensibly “manage money”. However this management amounts to the process described above: an inherently flawed system where profit, or loss, bankers are rewarded. Again let me emphasize: capitalism itself is not the problem anymore than medicine is the problem when someone gets sick inside a hospital. There are errors within systems that need correcting. Sometimes medical people don't wash their hands or follow the correct procedures. That can be a systemic failure when all the people involved in an operation together ignore good practice. Such failures are due to poor management: due to people making mistakes or trying to get around rules that exist for good reasons. Medicine as a system for making people well is not the problem when staff break hygiene rules. The same is true here: capitalism is not at fault, it's not the overarching system. Rather it's small failures within the system: individuals breaking rules and not correcting errors. It's like a doctor who spreads infection, lots of people get sick, and the doctor gets not only to keep his job, but no one seems to do much about ensuring he washes his hands.

What should have happened was to let the banks fail. Or at least let some fail. And there would have been a recession. Maybe a bad one. But this would correct the error. People involved would have learned an important lesson. Instead what happened is that the USA government didn’t let the banks fail by injecting funds. And it continues to give the large banks more money (effectively socializing the supposed pinnacle of global capitalism: Wall Street). But the USA government can’t do this forever - it’s already in debt worse than it has ever been. Ever. By a long way. And next time some huge “correction” happens because (for example, but not limited to: people being unable to make loan payments in large numbers) who will bail out the US government when it can’t make the new even bigger payments?

While doing this reading I stumbled across a number of speeches given by economists and others who claimed they understood the crisis. Most do not seem to (which is frightening). I think there is one good way to know whether a financial-type actually understood the crisis before it happened, and it’s the rule Michael Lewis seems to have used in his book: did they make the prediction, bet on it, and make money out of it? His book describes those people and is well worth the read. It can be found here. (The audiobook version was particularly good, containing some additional material like an interview with the author at the end).

The other people who claimed to understand the crisis, but actually did not (and don't!) are kind of nicely illustrated by this TED talk titled “The Real Truth about the 2008 Financial Crisis” by the chief economist of a financial firm (Brian Wesbury). I think I have seen the tautology “real truth” on UFO websites as well, but that aside the talk here https://www.youtube.com/watch?v=RrFSO62p0jk is an excellent example of explanationless prediction (a concept from David Deutsch's book "The Beginning of Infinity" (you can buy that via here!) What Mr. Wesbury, the economist, does is talk to a single graph for most of the 20 minutes and correlates meetings of the Federal Reserve with what a graph of stock market performance over the course of a single year, is doing. But he provides no explanation aside from saying “When the Federal Reserve meets the stockmarket falls” (as if it’s that simple). This is a man blaming the government. Now I happen to agree, as I said, that government intervention in these things is typically a bad idea. But this is just a diversion away from the real and actual causes. Of course the Reserve Bank Board was meeting often. It was a crisis they could do very little about and so the stock market was in free fall. You could easily have put any dots on your graph about any meetings that happened ever (for example meetings of your local McDonalds staff would correlate with the falling stock market in the year 2008. The occasions when you watched movies that year would correlate with the stock market falling. But none of those are causal.

The lesson here is: credentials (having a degree in economics or finance) and titles (being called a “Chief Economist” or an “Investment Banker”) doesn’t actually mean you know much about either the economy or investing. Anyone can learn anything. Sometimes it takes time, but a little bit of effort and we can all tell the difference between proper science-based medical doctors and homeopaths selling water (without needing a degree in medical science to do so).

I haven’t seen “The Big Short” the movie yet - but will as soon as it gets to Australia on the 14th of January. The movie, like the book, I imagine will be a dramatic re-telling of this through the eyes of characters who made lots of money by doing something very clever: selling "Credit Default Swaps". These CDS products were basically insurance on CDOs. If the CDOs ever went bad, even slightly, the CDS paid the owner a percentage of the total worth of the CDO. Millions or hundreds of millions. Again, this was a bizarre system, some very clever insightful people took advantage of. The CDS market allowed anyone, not just the CDO owner, to buy insurance. This would be like you being able to take out fire damage insurance on someone else's house. Not a good idea. (Think why! You could burn it down. Or hire someone else to burn it down. But even if everyone was actually an honest player and not a pyromaniac - if insurance companies allowed multiple insurance policies to be taken out on a single house then when that low probability event actually happens for real (someone leaves the oil on the stove and there's a fire) then the insurance company has to pay out the cost of the house multiple times to anyone who bought the policy). Another strange thing with CDS's were that as the crisis gradually became clear to many people they were sold not only to anyone who wanted to buy one but were being sold while the house was on fire. What a strange thing! And this, again, long story short is why the largest insurance company in the world - AIG - failed. The investment banks started buying CDS insurance on their own CDOs which they knew were bad but didn't tell AIG about. And AIG didn't think to ask because the CDOs were, remember, AAA rated by the "reliable, objective" ratings agencies.