In 2008 "synthetic CDOs" destroyed the global economy, and now they're back

At some level, there really isn’t anything wrong with pooling a geographically diverse bunch of mortgages and paying them off in tranches. It doesn’t eliminate any risks, but it does do something to manage them. You really can create bonds that are less likely to end up in default because some local plant closed, or there was a flood or other disaster. Pooling reduces the risk, but trancheing the payments concentrates that risk in lower tranches. And then re-pooling a bunch of those lower tranche bonds does almost NOTHING because the losses of those bonds is highly correlated Even the higher tranches created from them have similar loss profiles to the lower tranches. Either they all go bad, or none of them do, because they are all going to go bad if there is a national decline in RE prices. They are the opposite of fail safe By creating a system that will only fail with a national decline in RE prices and then lending ever more money out, at ever worse terms, to borrowers who have ever less probability of paying off the loans according to the terms, you ENSURE that there will be a national decline in RE prices.

The analogy that I use use is better, stickier tires. When you put them on passenger cars, they improve safety, because the limit on how fast you go is how willing you are to risk getting a speeding ticket. But when you put them on race cars, you do nothing to increase safety, because the limit of how fast the drivers are going is how fast a professional thinks they can go around the curves without getting in an accident. Instead of preventing accidents, you’ve just ensured that they happen at higher speeds.

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And taxed as gambling too.

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This is one of many failures of regulators to stay abreast of developments in the financial markets. If you want to sell stock to the public, you have to go through a lot of steps and do a lot of disclosure, and that’s for a security that is about as straightforward as you can get. So why are dodgy derivatives so much less regulated?

The other point is that I think there are really only a very few very big banks that are issuing this kind of stuff. Your ordinary run of the mill community bank isn’t in this business. We have let a few banks get too big and too complex. They are supposed to do risk analysis and have contingency plans if things go south for them, but I personally don’t have a lot of confidence in those measures. They are also passing on a hell of a lot of risk to the buyers of these things.

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Isn’t the real problem here that the rentier class got much richer from the crash of 2008, and eleven years of austerity have made them much richer still. No one cares if the economy collapses, it’s just more opportunities for profit. And tumbrils be damned.

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