The movie is based on a book. Do you feel the book's author (Michael Lewis who has written about mortgage backed securities for years) also doesn't understand the theory behind CDOs? Or that the filmmakers didn't understand the book?
The book and movie does briefly explain all this, but it paints a picture that the instruments themselves were inherently toxic, which was not the case. What was toxic were the assumptions that went into modeling their risk characteristics.
The assets (like all assets) themselves were fine. The problem was that people didn't understand them.
The clearest example here is shares in a Ponzi scheme. Those are definitely assets, and they are definitely not fine. They are made to not be understood. The same is more subtly true of the previous wave of essentially fraudulent mortgage-backed securities. But I think the same is also true of any hard-to-understand instrument engineered to look like a good deal at first glance.
You also ignore systemic risk. For many years before the 2008 collapse, cognoscenti knew that a lot of risk had gone somewhere, we just didn't know where. But we sure found out! Saying that "all assets are fine" is sort of like saying "all chemicals are fine". It's technically true, in that dioxin and DDT don't intend to be harmful. But if the evidence shows that people can't use them responsibly, then a ban in a totally reasonable outcome.
It isn't the case that nobody understands them. We understand them just fine now. This is how civilization learns. For a long time we didn't know how to price options - now we're quite good at it.
> The clearest example here is shares in a Ponzi scheme. Those are definitely assets, and they are definitely not fine. They are made to not be understood. The same is more subtly true of the previous wave of essentially fraudulent mortgage-backed securities. But I think the same is also true of any hard-to-understand instrument engineered to look like a good deal at first glance.
Ponzi schemes are designed to defraud unsophisticated investors. These assets serve a useful purpose and work just fine as long as their risks are properly understood, which they now are.
> You also ignore systemic risk. For many years before the 2008 collapse, cognoscenti knew that a lot of risk had gone somewhere, we just didn't know where. But we sure found out! Saying that "all assets are fine" is sort of like saying "all chemicals are fine". It's technically true, in that dioxin and DDT don't intend to be harmful. But if the evidence shows that people can't use them responsibly, then a ban in a totally reasonable outcome.
The evidence does not show that for these assets. You could make a similar case about basically any dangerous but useful technology. When dynamite was first invented i'm sure a lot of people died messing with it. That doesn't mean we should ban it, it means we need to figure out how to handle it and use it safely. We now understand these assets pretty well. I'll bet you basically whatever amount of money you want that the next crisis will not come from these assets.
I agree it's possible that these assets could be fine now, either because people have truly learned a lesson, or just because of the "once bitten, twice shy" reaction that takes a few decades to wear off. But the principle by which you declare them fine, namely that all assets are fine, is definitely wrong.
You could make this argument about literally anything. You're not really saying anything specific to CDOs here, so I can't really give you a more specific response.
> I agree it's possible that these assets could be fine now, either because people have truly learned a lesson, or just because of the "once bitten, twice shy" reaction that takes a few decades to wear off. But the principle by which you declare them fine, namely that all assets are fine, is definitely wrong.
All assets are fine if you understand their risks. Sometimes we deem certain people or groups insufficiently responsible to handle the risks of certain assets. Non-accredited investors are not allowed to invest in private companies. The United States bans "contracts for difference", etc..
I think the problems with CDOs are extremely well understood at this point by everyone in that market. It has been one of the most studied issues of the last decade in quantitative economics. That isn't to say that it's impossible that there's some lurking risk we don't yet get. There absolutely could be. But the probability is much lower than basically any other complex asset class, precisely because this is the one that blew up last time.
If you want to go hunting for latent risk, CDOs are literally the last place you should look. Our economy is chock full of astoundingly complex financial instruments. If you are worried about CDOs because they blew up last time, you are really really missing the point.
If we used your system for banning assets, we'd have banned the stock market in 1929. We'd have banned tech stocks in 2001. Argentina would have basically banned all money by now.
My point is: just pointing at the fact that something blew up once is an insufficient argument that it is not worth the risk. The pattern of "new thing blows up in our face" is quite common across things that turn out to be incredibly valuable and useful. The question at hand is whether we understand it sufficiently well now to use it safely. And the answer is pretty unequivocally yes. We know what we did wrong with CDOs and we know how to correct for it.
I do agree that, "All assets are fine if you understand their risks," is moving in the direction of a reasonable principle. So you're making progress. Once you start to grapple with intentional information asymmetries, willful misleading of buyers, and engineering for complexity as a way of hiding risk, you might really get somewhere. I doubt you'll get far enough to prevent the next crash or anything, but definitely somewhere.
Of the people who did know about CDOs, many should have understood them, because they were playing around with sums large enough to affect the economy as a whole. They didn't through a combination of inertia and fraud.
There were systemic effects, where a whole lot of people were making apparently sensible local decisions and nobody understood the entire interaction -- but that's not really a good justification for shrugging shoulders and say, "Well, I guess it's everybody's fault, then".
People should be able to make the "assumption" that they'll be able to work in a functioning economy, without having to become experts in complex financial instruments. If the financial industry can't leave them to make that assumption, they'll vote for a government that will enforce it -- probably clumsily. If the system requires everybody to understand a financial network that most of them can't, they'll forbid it, which isn't good for the economy but is more acceptable to a lot of people than being told that the financial crash was their fault.
Sure, but i'm not sure what this has to do with my point. Should we ban internet stocks because the market was irrational in 2000?
> There were systemic effects, where a whole lot of people were making apparently sensible local decisions and nobody understood the entire interaction -- but that's not really a good justification for shrugging shoulders and say, "Well, I guess it's everybody's fault, then".
Ok, but how does that cash out in any kind of coherent policy recommendation?
This industry has been failing systemically often enough to consider the product a liability.
The classic example is a put option. If you think a stock will go down in a future, you could short that stock; but if instead the stock goes _up_, you could be on the hook for an infinite amount of money. Instead, you can buy a put option and get a similar payout if the stock goes down, but if it goes up, you've only lost the money you spent on the option.
Another example is purchasing futures: if you're an airline and you think fuel prices are going to go up, you can buy up a messload of fuel futures, and you'll effectively pay the same price for fuel while everyone else is paying more (which I think JetBlue did in the 00s).
In this case, a CDO theoretically reduces risk by spreading your risk across a huge number of mortgage holders. If you sell someone one mortgage and they default, then whoops! You just lost a ton of money. But if you instead sell 100 different mortgages, you're "diversifying" your risk. Most people don't have billions of dollars to sell thousands of mortgages to make this sort of investment, so CDOs package the mortgages into purchaseable portions.
(Of course, what happened during the housing crisis was that there was a huge, systemic issue that would cause huge swatches of mortgages to default. That part sucked, and the contributors to that catastrophe definitely deserve the ire on them.)
[Disclaimer: I'm relying on my memory of finance classes I took 15 years ago, I'm probably wrong about some details.]