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Back just after the dinosaurs left, loans defaulted routinely at a small rate. Adjustments were made (such as insurance for the loan payer) to mitigate against some percentage, But always within the cost of any loan is some percentage betting on default.
What the CDOs did was pre-bet that this cost could be spread about, so that looser money could be spread about. But there was a mistake made, in that too many people were cross betting. All the cards that we supposed to be supporting the other cards turned out to be reliant upon upper cards.
And thus it is called a ponzi scheme...though that tends to dilute the rank and number of people involved.
I just hate this 'holier than thou' attitude when discribing those who were buying in with offers that got them out of the economic cycle they were in.
That this was part of the disguise and repercussions of the Savings and Loan bailouts from 15 years before is a whole 'nuther tangent.
Never underestimate their intelligence, always underestimate their knowledge.
Frank Delaney ~ Ireland
Plus the very strong pull of the "American dream": owning one's home (the US legal system is based on the property laws; unlike Europe, tenants have nearly no rights -- I know, I've been there).
When the nice mortgage broker explains that you too can be part of that home ownership dream: this is entirely legal (would I lie to you?) and when the introduction rate expires you'll have build plenty of equity in your house and refi will be a snap, not many people could resist the "dream".
Of course, the whole system worked (for a time) because neither the broker, nor the bank, nor the big guys like Goldman were holding the bag: they found a way to offload all the risks onto someone else while keeping the profits -- the very definition of modern finance.
A good opportunity to watch again this excellent presentation "How Subprime Works". Should be required reading on ET.
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