The Big Short: Inside the Doomsday Machine

Less dramatic than the movie, but more informative.

It walks through the bestiary of would-be homeowners, mortgage originators, mortgage bond packagers, agencies who rated the mortgage bonds, purchasers of mortgage bonds, and people who shorted those bonds. In particular, how did these different players' opportunities and incentives end up getting twisted so badly that banks went bust globally.

One particularly nice example: a mortgage bond’s rating is assigned by a rating agency based on the estimated risk of the mortgages it contains. Packagers started experimenting with the characteristics of the bonds they were assembling into bonds and submitting to the rating agencies. Clever/lucky packagers found that rating agencies rated risk of mortgage bonds based on the mean FICO score, rather than any more robust summary statistic. And because the bond itself is considered to be diversified against any one mortgage failing, that minimum mean value is low. Also, rating agencies didn’t distinguish between ‘thin-file’ FICO scores (those based on little or no borrowing behavior) and longer credit histories. So the packagers started buying more high-risk (low-FICO and no credit history) mortgages, mortgages which originators usually had difficulty selling, at bargain prices. This spurred originators to start selling more high-risk mortgages.