Asymptosis

Update: I erroneously attributed the following post to Tyler Cowen instead of Alex Tabarrok. Fixed in the title.

Marginal Revolution: The Dark Magic of Structured Finance.

I’ll let you read it yourself, but here’s the takeaway. If the chance of underlying mortgages’ defaulting goes from 5% to 6% (a 20% increase),

the probability of default in the 10 tranche[s] jumps from p=.0282 to p=.0775, a 175% increase.  Moreover, the probability of default of the CDO jumps from p=.0005 to p=.247, a 45,000% increase!

These securities don’t just leverage the risk; they massively leverage the risk of risk.

Related posts:

1. Did Fannie, Freddie, and the Community Reinvestment Act Cause the Meltdown? Uh uh.
2. Should the Financial Sector Shrink?
3. Teddy Roosevelt on “the true conservative”
4. The Global Great Depression: Then and Now
5. The Real Return on Treasuries Should be Zero. They’re Risk-Free.