On Credit Default Swaps and The Mess We're In

[billroper]

By way of The Volokh Conspiracy, here's the best explanation I've seen of how Wall Street managed to convince itself that the rules about systematic risk had been repealed.

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[patoadam]

Warren Buffett agrees:

"The stupefying losses in mortgage-related securities came in large part because of flawed,
history-based models used by salesmen, rating agencies and investors. These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible. They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn’t afford. In short, universe “past” and universe “current” had very different characteristics. But lenders, government and media largely failed to recognize this all-important fact.

Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas."