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December 3, 2007

Today's Housing Bubble Post - "Spooked," "Crisis"

-- by Dave Johnson

Paul Krugman : Innovating Our Way to Financial Crisis,

The financial crisis that began late last summer, then took a brief vacation in September and October, is back with a vengeance.

How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.

Don't feel too badif the underpinnings of this crisis are more complex than you have time to grasp. Partly it is happening because things became so complex.

For just one illustration of the complexity, here is what happens when a "CDO' is "unwound." A CDO is a big batch of mortgages and other debt, backed by collateral. That's the C in CDO: Collatoralized Debt Obligation. To find out what is really in your CDO you should examine each one of the mortgages (car loans, etc.) to see if the mortgage-holder really does have all the income that is on the application, and whether the house was appraised properly or is really worth less than what is still owed on the mortgage, etc. And that is just one level of the complexity.

You might ask, why didn't the buyers of these CDOs check these things before they bought them?

Indeed.

Posted by Dave Johnson at December 3, 2007 9:00 AM

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