re: #409 eschew_obfuscation

You can have $100,000 of equity in your house, and use that to borrow maybe 5 times the amount in a mortgage. These brainiacs figured that by pooling thousands of mortages, they were spreading out the risk, and therefore diluting it, and then could borrow at even greater leverage ratios.

Institutions with $10 billion in assets were insuring other institutions for 30 times that amount, $300 billion. These institutions were in turn using default credit swaps to lend other institutions $10 trillion, and so on. There were huge amounts of virtual money passing back and forth. They convinced themselves they had the correct mathematical formulae for evaluating risk and therefore were safe. They forgot that the underlying assets, mortgages included some very unsound subprime mortgages. The house of cards collapsed.

Leverage works in both directions. When the debts were called in, the banks had no only 1/30th of the assets to cover their obligations. And so it all came tumbling down.