Just in case nobody's linked to it in these comments yet, I highly recommend Nouriel Roubini's blog & TV appearances for the best analysis of what's happening. He's been predicting these events for years and all the "serious" analysts just called him "Dr. Doom" - guess he wasn't so far off base after all...

http://www.rgemonitor.com/roubini-monitor

Argh, such painfully bad analysis. Investors have been insuring low-probability events for centuries, an they generally don't lead to collapse.

The problem had much more to do with people not knowing how risky various bets actually are, and a bunch of events being tied together so they all happen at the same time, in ways that weren't predicted. It your painful analogy, it would be more like:

I made the bet that San Francisco would win the NBA, another about the MLB, another about the NFL, and another about ML Soccer championships (note SF may not even have a team in every sport). The independent probability that all of these would happen is astronomical.

But then some put steroids in SF's drinking water, and someone at UC Berkeley cloned history's greatest sports stars, and the city of SF becomes a sports powerhouse, and wins every single one hands down. And the probability of this happening, was actually a lot higher than the independent probabilities multiplied together.

Also, credit crunches really suck, and that fact is independent of how exotic trades are today.

That's about as dumb an nalogy as thinking Hillary was going to defend Obama to the Jewish Community tonight (she's not, she cancelled after having to explain why Obama befriends the worst Anti-semites).

First, insurance is not based on 'bets', its based on assets.

Disagree. Not a good analogy.

Forget the no-one-is-actually-able to pay part. The premise makes no sense.

With insurance, I get $95 if the 49ers don't win, and $95 if they do, since my neighbor covers my losses. Great deal for me.

My neighbor makes $5 if they don't win, and loses $100 million if they do. Terrible deal. He could go to my bookie, take out the same bet I did, not insure it, and still get better odds ($100 if they don't win, lose $100 million if they do.) And why would the entire neighborhood imitate him?

You're missing the key part of this fun little game. I know that my neighbor doesn't have the $100 million - he drives a Civic - so why do I keep giving him the nickels? Because this way I don't have to tell the rest of the world -like my bondholders and shareholders and other business partners - that there's a risk that in 2 years I might be $100 million in the whole. After all, I'm insured for it! The insurance is a scam and only the suckers don't know it.

A maybe better analogy that only poker players will understand:

AIG is a Texas Hold'em player, drawing on a four-part flush without knowing there are 20 cards missing from the deck.

You're something like a million times smarter than I am so I hesitate to be critical but oh my goodness are you off base here - for all the reasons listed above and, most terribly, because your analogy makes the perpetrators of these crimes sound like dopes instead of the miserable pirates they are.

Don't spend time trying to find analogies and instead point people to This American Life's The Giant Pool of Money, which does the best job yet of explaining what happened and why. Evil people saw money, wanted more, cheated and lied to get it and then ran away leaving the slower, less connected people holding the bag. And Alan Greenspan, patron saint of the looting elite, is the leader of the band.

8:02PM anon has it right.

Buying insurance means that you get rated as a good player by the people who grade this shit, and selling insurance means that the seller gets rated as a good player too.

Kindleberger's Manias, Panics and Crashes is a very good read on this.

Anyone who wants to understand how these "credit default swaps" were bought and sold, how Congress destroyed the ability of regulators to control them, and what might happen next, should listen to Terry Gross's interview with Michael Greenberger, here:

http://www.npr.org/templates/story/story.php?storyId=94686428

..'makes them sound like dopes instead of the pirates they are'

Why because they managed to play the system and the customer at the same time? It was traditionally the governments job to watch over these systems and make sure recursively bad securities werent made. We gutted that system so the pirates as you call them had it free and easy.

They weren't dopes, Im sure that the majority of them knew they were building a house of cards. It doesnt matter however, the people building these companies are outrageously rich and many have retired and moved on. Their dynasties are secured forever, and the company be damned.

This is the free market at work. All profit all the time, with no heed to ethics, pride of production, or national integrity.

Ideally we could call it all a scam and just erase the majority of this debt if we all owed each other this debt. The rich would be less rich, but nothing would be materially lost. Unfortunately we got even deeper into this then that and started selling the majority of these securities overseas. Thats the true dilemma behind Fanny and Freddy, it wasnt just that if they failed some shareholders would go bankrupt. We have been financing our foreign debt through them and cant afford to pay it all off.

Sometime soon the reality is going to hit that we as a nation need to start living within our means. Even if it means that China forecloses on our national debt and puts the squeeze on us big time.

What's extraordinary is how broad and deep the corruption is. From each and every realtor and suburban banker to the office drones and assistant vice presidents, to the lawyers, investment bankers, and bond salesmen, right up to the top - they all knew that this was crime they were playing with, and they didn't care because they were getting paid.

While Barack Obama was pocketing over $500,000 dollars from Lehman, Fannie and Freddie over the last 3 years, McCain was actually trying to fix the problem:

John McCain. 25 May 2005, speaking to the Senate:

Mr. President, this week Fannie Mae’s regulator reported that the company’s quarterly reports of profit growth over the past few years were “illusions deliberately and systematically created” by the company’s senior management, which resulted in a $10.6 billion accounting scandal.

The Office of Federal Housing Enterprise Oversight’s report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae’s former chief executive officer, OFHEO’s report shows that over half of Mr. Raines’ compensation for the 6 years through 2003 was directly tied to meeting earnings targets. The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac.

The OFHEO report also states that Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator’s examination of the company’s accounting problems. This report comes some weeks after Freddie Mac paid a record $3.8 million fine in a settlement with the Federal Election Commission and restated lobbying disclosure reports from 2004 to 2005. These are entities that have demonstrated over and over again that they are deeply in need of reform.

For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the GSEs need to be reformed without delay.

I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

I urge my colleagues to support swift action on this GSE reform legislation.
--------------------------

The legislation was blocked by Democrats. Obama was bought and paid for.
If anyone thinks he would fix anything, its based solely on HOPE, not anything the man has ever actually done.

Sooo, who didn't gamble so I know where to put my money.

The whole "greed" and "pirates" thing really makes no sense to me. The people making these investments were trying to make money -- you can call that greedy, but that's the name of the game.

These were not seen has high risk investments, but relatively safe stuff. And these companies were trading with their own book, not dumping it on the unsuspecting public. So how are they pirates?

The problem was with the alchemy that purportedly transformed, through layers of securitization, bad home loans into AAA notes. Everyone believed it, but it wasn't true.

If everyone knew the purported diversification offered by securitization was a joke -- and they were all acting greedily -- why didn't they just reverse their "bet." Some people saw it coming and made billions. But most didn't.

And frankly, to some extent AIG must have saw it coming. They stopped doing credit default swaps for CDOs in late 2005/early 2006, more than a year and half before the credit markets plummetted in August 2007. But they apparently took on too much by that time already.

It's sort of amazing to think that we've been paying finance CEOs incredible amounts of money to follow each other off a cliff, but there you have it.

modern finance and the whole diversification business is built on finding non correlation (statistical independence).

But correlation's a bitch!

There's one part left out of this analogy: the part where the 'Niners started to get really good, and won the first Super Bowl, and then got some great new players, and lots of commentators were saying that they were looking like a good bet to repeat.

That's the part I don't understand -- it's not like the impending collapse of the real estate bubble just came out of nowhere. I factored the likelihood that prices would stabalize or drop into my own personal real estate decisions. So did most of the people I know who've bought or sold homes in the last few years. But somehow all these MBA geniuses on Wall Street based deals on the assumption that it would go on forever. I really don't get it.

Greed (which is destructive enough) may be the name of the game but now usury is as well. I'm not a huge fan of most any religion you can name but one thing the big ones all have in common is a prohibition against usury. That's not b/c it's a "bad" thing necessarily but b/c it's an unsustainable model for a society. We're seeing that fact play out now.

And I don't buy the assertion that investors thought this stuff was safe. If they did, they were fools. If they didn't they were thieves. Both sorts need to be heavily regulated for their own good and ours.

It's sort of amazing to think that we've been paying finance CEOs incredible amounts of money to follow each other off a cliff, but there you have it.

These lines are tired and ignorant. There are a whole slew of people in Wall Street beyond "CEOs" who are responsible. Investment bankers, hedge fund partners, etc. Kristof's column this morning inexplicably calls outs CEOs and applauds the compensation to the latter groups. Why? Its ignorance of finance, Wall Street and the current financial crisis. The "CEOs" line is used by those with enough sense that some folks have been unjustifiably compensated by taking foolish risks, but too ignorant to know exactly who. It sounds like Ezra is part of the "CEO" crowd.

PAT,
Look up the Gramm-Leach-Bliley Act of 1999.
Sorry about McBush.

….Look up the Gramm-Leach-Bliley Act of 1999…palin

Interesting, a little research shows that McCain didn't vote on the final bill. So
perhaps you should refer to Obama's famed donor base, you know, those nickel and dime contributors.

….The problem with Obama’s rhetoric rests in the fact that tucked away in his database of 2.5 million donors is the approximately 180,000 power brokers that have funded nearly 60% of his campaign. Included in this list are the more than 594 campaign bundlers including 15 lobbyist bundlers who have accounted for over $140 million in contributions. …
Including:
John Rhea - (over $500,000) Co-Head of Lehman Bros. Global Investment Banking
Mark Gilbert - (over $500,000) Lehman Brothers Senior Executive
Christine Forester - (over $500,000) Lehman Brothers Senior Executive
Theodore Janulis – Bundler (over $100,000) & Lehman Brothers Head of Global Mortgages
Nadja Fidelia – Bundler (over $50,000) & Managing Director of Lehman Brothers
… Robert Wolf, the CEO of UBS Americas, helped the Obama campaign raise more than $500,000. That amount was equaled by Louis Susman, the Chairman of a Citibank Subsidiary. [UBS, employer of Phil Gramm, a man who is so nasty even his friends don't like him. Oh wait: he's McCain's boy.]
…
Michael Froman – Over $200,000 Managing Director of Citigroup
David Heller – Over $200,000 Managing Director of Goldman Sachs
Bruce Heyman - Over $200,000 - Managing Director Goldman Sachs…

If you seriously think that Obama would not have voted for that atrocity, you are living in the HappyLand of Delusion where Obama rules. There's zero evidence in his record to support your hope.
If you are counting on these people to save the economy, you're a fool.

Anonymous above was me.

I like Econospeak's analysis, but that analogy basically applies to all bubbles -- and there have been booms and financial panics in this country, with near-clockwork regularity, for about two hundred years. If anything makes the current crisis remarkable, it's the extremely interconnected and intricate nature of our financial system (all that messiness about repackaging bad loans as good). AIG, let's remember, was a pretty good company. It was one of the few AAA+ rated businesses in the world; it had subsidiaries that should have been safe from the credit crisis, like airplane insurance. But the housing crash infects just about everybody.

Think of it this way. If you are that neighbor getting a nickel a week, your job is to decide what the best use of your capital is, right now. Maybe you can see that the 49ers can't win forever, but you don't know when their spectacular streak will end. If you don't want to go out of business, you have to insure those bets, or somebody else will. That's neither dopiness nor piracy; that's a hazard built into the financial system.