Most of this crap is not that hard to understand. The problem is that the salesmen on Wall Street keep making up new names for stuff. They even mock this tendency at the end of the movie by referencing the latest thing called a "bespoke tranche opportunity". In plain English, they just mean that they hand picked (bespoke) a bunch of mortgages (the tranche) and want to sell it to you quickly before it starts to smell (opportunity).

A CDO is just where you create an entity (basically a company) to own the loans and sells shares in it to fund the purchase of the loans. Sort of like a mutual fund. They just keep doing this stuff in more and more layers, giving it different names each time, but really it's not as complex as they make it out to be. The connections can get complex, but the components are pretty straightforward.

The worst part is that they fool themselves. Greedy is bad, but greedy and stupid is even worse...

the banks. Then most homeowners would choose to pay up their mortgages and keep their homes. But if not or if they're too far into foreclosure and/or if the banks refuse to work with them, then screw the banks and keep the money.

But they also should have done something about predatory interest rates. What kind of level-headed Marine would buy a house requiring an additional $2000 per month? Maybe he lives in a high-priced area, but around here you can easily get a nice 3-bedroom for less than $1000 per month fixed rate, so that would be a mansion. I'm sure many people of modest means knew better than to buy mansions, so interest and fees must have been horrendous.

I always used the following explanation to get people to understand the financial shenanigans that went down in the 2000s that led up to the 2007-2009 crash.

One facet was something called Credit Default Swaps (Swaps). Swaps were a "finanacial innovation" thought up by the big bankers, insurance, and mortgage companies. They are insurance policies against loan defaults.

Let's say you bought a house and took out a loan for $200,000 from Bank A. This was a subprime loan where the interest rate would start out very low, and then spike in the future after a certain number of years. Of course, Bank A would be worried that you might default on the loan after the interest rates spike, so they would take out insurance against that possibility from another bank--say Bank TOP, for $200,000 in Swaps. Bank A would pay Bank TOP a monthly fee for the insurance policy and Bank TOP would pay Bank A $200,000 if you defaulted. By making a number of these Swap policies, Bank TOP would make a nice profitable income via these fees so that they looked profitable.

However, under the "innovative" rules of the time, Bank TOP didn't need to have that $200,000 in capital to back up its Swap policies. In fact, it didn't need to have any money at all! Also, Bank A would ask other banks to insure the same mortgage loan, so, Bank DNC would also insure your loan for $200,000 (which they didn't have in capital), and Bank Switzerland would also insure your loan for $200,000 (which they don't have to have on hand). What happened was that many loans would end up having many such Swaps insuring the loan--so your $200,000 loan might be insured for $1,000,000 via multiple banks/insurers/mortgage companies. That $1,000,000 doesn't have to exist anywhere.

Bank A would be making similar Swap arrangements for loans that other banks made. A good, steady source of income.

But, during the course of business, Bank A would realize--hey, if you default on your mortgage, instead of getting interest on $200,000, they'd get a $1,000,000 payout! So, Bank A would make these subprime rates more and more onerous over time so that more people default, and they'd get more money!

This went on for some time, and around 2007, the Swap market was insuring loans (home, business, etc.) to the tune of $60 trillion. That money did not exist anywhere at all. The money wasn't real. There really isn't that much money in the world. But the debt that would need to be paid out by banks if everyone started defaulting was real--a legal obligation. So, when things turned south, banks suddenly owed trillions of dollars that they couldn't pay.

So, the government stepped in in various ways--with our taxpayer money--to bail them out. Direct loans to banks, quantitative easing, etc. They didn't pay off $60 trillion. But they did do enough to stop the drop, to the tune of trillions of dollars (I seem to remember the number $4 trillion being tossed around), and life went on. But not much changed in the financial innovation sector.

This was made possible partly by the repeal of Glass Steagall, which made a rule that banks couldn't get involved in insurance or speculative investments, and that banks, insurance companies, and investment companies had to be separate. This was also made possible by the complete lack of regulation around Swaps.

Swaps were only one part of the crisis, but they were a big part. There were other financial "innovations" that went bad and had their own far-reaching effects. Banks were TRYING to sign up people who they knew would not be able to pay the subprime mortgages when the rates spiked, because it would mean a lot of money for them once the mortgage purchaser defaulted. (Insurance payout!)

Often, people don't really understand how this all went down, or why. Although there are a couple new regulations in place (banks have to have a higher percentage of capital versus their potential obligations, for example), these are in no way adequate to handle a large recession or depression. I hope this example clarifies for some at least one aspect of what went down and how these "innovations" take place.

There is now more fake money out there being played with than in 2007. Nothing has really changed. The next time things go bad, it will likely be a bigger crisis, and at some point the government won't be able to handle it.

Thanks for this, OWN. Your essay is something we could direct folks to when they comment that they don't really understand the causes of the Great Recession.

I studied the GR and came to the same conclusions as you have presented. In the process, I found numerous online sites that were following the situation and were able to teach a layman about the economics involved. One of the best sites is one linked to the left on C99, Naked Capitalism. I found that I was forced to head out of my comfort zone in my search for accurate information. Sometimes I wound up at right-wing leaning sites, but only those who detested corruption.

For instance, I had discovered Karl Denninger long before Santelli's rant on the floor of the Chicago Board of Trade. I found myself at Mish's place, patrick.net, The Big Picture, etc. All of this was before the genesis of the Tea Party. Denninger had framed the Tea Party long before Santelli, so I was in on it early. I remember going to a couple of early local Tea Party meetings in my area. The first few were very bipartisan affairs, and also very multi-racial. Many of us did not consider the movement in those early days to be right-wing. That changed almost immediately. I recall the second meeting I attended. The confederate flags suddenly showed up. When they did show up, I remember leaving in disgust. Walking away with me were all the people of color who had come. It was a big wake up call for us. Later, even Denninger denounced the Tea Party when they started misdirecting the blame for the recession.

My primary reason in voting for Obama was that he convinced me that he would go after the Wall Street firms that had crashed our economy, and also the changes in law that allowed it to happen. I knew within a week that I had made a mistake. In fact, I suspected it the night of the election. That night, when leaving the celebration in Chicago, some reporter shouted some question at Obama (don't remember the question and it doesn't matter). It was his reply that got me. His answer to the reporter was one sentence: "I'm going to surprise a lot of people." I never forgot that he said that, so I realized when he started naming his cabinet members exactly what he was talking about. All his promises during the campaign were what he later referred to as, "...just campaign rhetoric." He actually said that. I've tried to find video of each of these statement he made (all on camera), but have never been able to dig them up.

Anyway, I'm rambling.... Thanks again for your thoughtful and accurate essay.

Whenever you hear that, there is badness going on.

I mean really--if there is one place "innovation" shouldn't happen it's in finance. Maybe with regard to technology is okay--but even then, not really. Most stock trades are now performed by machines to the benefit of companies and to the detriment of individual shareholders. Another "financial innovation" that is probably doing citizens more harm than good.

Moody's and Fitch etc, rated these credit default swaps highly. This allowed the banks to go deeper and deeper into their scam while their rating agencies committed fraud by saying all is well.

We still have credit swaps....why ? What is the purpose of these "instruments" except to obfuscate the real value of any given loan ? It's BS created by very smart and fraudulent actors.

Meanwhile, Big Banks Frank and her heinous are very confident there are no more economic shenanigans going on. I call bull shit. Just like Moody's gets paid by banks to rate banks, Clinton/Frank et al get paid by banks to regulate banks. Gee, what could possibly go wrong ?

How now (brown cow) to hedge against the looming Bigger One? Withdraw enough from savings (lol) to bury in the back yard for a rainy day? Invent another shadow bank industry? Learn barter, of course. I am still not good at that, on the learning curve now.

Damn, my turnip crop ( as others) failed this year, but I am no recognized Farmer so did not buy crop insurance, which this year would been a good investment locally, as we now qualify (farmers only) for drought relief. MY "crop" here is firewood, 20 acres of trees, enough downfall that I have local pickers, who I tolerate, but net no write-off for my generosity. I carry enough liability insurance that I could absorb an injury by tree...

Still carrying a HELOC, paying down slowly, as the interest rate is 3.25%, and the tax deduction is there. I could not pay off the little bugger without bankruptcy. Very invested in real estate, over-exposed there. And I have a $400K fraud lawsuit about the smaller half of that, in another country, so Jubilee would be no help. And the Big Re-assortment looms large.

http://www.rollingstone.com/movies/reviews/the-big-short-20151210

Great piece, OaWN!