For those who don't understand what derivitives are, think of them as "loan insurance."
One bank pays another bank to cover the risk for a package of loans that it has, carefully crafted with deals from with morgages from all over the country, because up until the national housing bubble, there has NEVER been a nationwide crash. Housing bubbles are pretty much always localized in one or two cities... because cities fortunes rarely change togther and people are moving SOMEWHERE.
So I give pay you $200 a month say to cover 5 loans from NY, Dallas, LA, Chicago and Miami. The chances that all 5 of those are going to fail is minimal and as long as one of them succeeds we're fine. Heck as long as a few derivities sold suceeds we're fine.
However what happened was, due to the aforementioned subprime loans and other loans in general, the number of "risky owners" was waaay too high, and default rates started to be waaaay to high, nationwide, because nationwide loaning being too loose was the cause of the bubble.
Now this caused failures that caught that banks off guard because the failures were so paramount they had more debt then they had money. So they had to start calling in other loans raising the interest rates, rates that lots of people weren't able to pay, and the whole thing collapsed hard. (Hence why the number of sub prime loan defaults is a small amount, they started the avalache they weren't the avalanche.)
Were there not such agressive measures for EVERYONE to own a home there would of been no problem... ever.
