“The credit default swaps were pure fraud.”
CDS had been around for decades. They are an insurance product for debt. But the financial industry made sure that they were unregulated by getting Congress to pass the Commodities Futures Modernization Act. You can read about it by googling Brooksley Born.
“Also, they represented crap loans as a clean product when bundled. They sold it as grade A knowing it was garbage and were betting against them in the market.”
In reality most of those bundling the loans didn’t know that they were bad and the proof is in the fact that they were holding on to those same CMOs. The financial industry fooled themselves by using a risk formula that they didn’t fully understand, David X Li’s Gaussian copula function, which led them to believe that their risk was minimal when it was gigantic. And to top that off the three rating agencies all rated this paper as AAA, reinforcing the belief that there was little risk.
The only people who seemed to know that something was seriously wrong were those close to street level, who could see that loans were being given out to anyone who could breathe. I was part of a small crew beating that very drum here at FR, with ex-Texan being the leader of the pack IIRC. It wasn’t a popular opinion at the time.
I enjoyed the movie "The Big Short" which put much of what you've described into layman's language.