Weren’t the banks also able to invest in the derivatives based upon mortgage backed securities? The ‘CDOs Squared’, the ‘Synthetic CDOs’, and other instruments that Warren Buffett in a moment of clarity mockingly called “weapons of mass financial destruction”.
I thought that this was the sort of fire that banks had been able to play with.
I know that Credit Default Swaps (CDS), which are more of an insurance product than a derivative, played a big role in the mess. There was a way to use an unlimited number of CDSs to bet against the very mortgages that you were writing, even when you didn’t hold any of them. An incentive to write bad loans knowing that your CDSs would pay off when the mortgages defaulted.
Synthetic MBS and synthetic CDOs are definitely derivatives.
I thought that this was the sort of fire that banks had been able to play with.
Most banks had nothing to do with the synthetic ones, they lost their ass on plain vanilla mortgages and MBS.
There was a way to use an unlimited number of CDSs to bet against the very mortgages that you were writing, even when you didn’t hold any of them.
When Goldman, for example, created synthetic MBS and sold them, they, Goldman, had the other side of that bet.
Like when you write (sell) an option, you have the opposite market position as the option buyer.
An incentive to write bad loans knowing that your CDSs would pay off when the mortgages defaulted.
If you can get someone to take the other side of the bet, sure.