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Banks mask risk through complex financial instruments from "summary" of The Big Short: Inside the Doomsday Machine (movie tie-in) by Michael Lewis
Banks had many ways to disguise risk. They could, for example, buy insurance on the bonds they owned. If the bonds defaulted, the insurer would pay up. Thus, the risk appeared to be elsewhere, with the insurer, rather than with the bank. This kind of insurance was known as a credit default swap. It was not an insurance policy in the traditional sense of the term. It was a bet. A hedge fund could, for example, buy insurance on a bond it did not own. If the bond defaulted, the hedge fund would collect many times the amount of the insurance policy. The banks created a market for these bets. They made the bets so complicated that the people who bought them didn't fully understand the risks they were taking. The people who sold the bets didn't fully understand the risks either. The complexity of these bets made it difficult to assess the true level of risk in the financial system. It was like a game of pass-the-parcel, with the music playing l...
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