Like the scene from the The Return of the Secaucus 7, earlier I was asking for details on the actual mathematics upon which derivatives, CDOs (Collateralized debt obligations) are based.

Wired Magazine has answered the call in the article Recipe for Disaster. This article outlines the actual mathematical formula, a Gaussian copula, upon which so many derivatives are based.

In 2000, while working at JPMorgan Chase, Li published a paper in The Journal of Fixed Income titled "On Default Correlation: A Copula Function Approach." (In statistics, a copula is used to couple the behavior of two or more variables.) Using some relatively simple math—by Wall Street standards, anyway—Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps.

You must read the entire article, yes they mention mathematics, but they are explaining it all in layman's terms.

One thing I did not know, pointed out in the article, is that there are no limits on the number of CDS (credit default swaps) that can be issued against one borrower. CDSes are literally unconstrained by are subject to mark-to-market.

Around 8 o'clock in the morning on July 5, 1934, shop owners in the mission district of San Francisco were opening for business. Bankers and stock brokers were already at work in the financial district. Construction workers were busy building the new Oakland Bay Bridge.

Meanwhile, down near the waterfront, a Belt Line locomotive began nudging two refrigerator cars towards Matson Line docks on Pier 30. 1,000 police prepared to square off against 5,000 striking longshoremen in a pitched battle that would last all day long.
It was the first of two climatic episodes that would forever change the shape of labor unions on the west coast.

Prelude

On Friday there was a conference on the financial crisis. It was held at Columbia University. Some very good interviews came from Economists Stiglitz, Volcker, Phelps and Bhide.

Below is an interview with Economist Joseph Stiglitz clearly stating the United States is putting good money after bad money. This is a fact we, those insignificant regular folk, have been saying for some time. Stiglitz also reviews what should be done with insolvent banks, discussion of Treas. Sec. Geithner's stress test and why a stress test based on a bad model or wrong assumptions is a problem.

While recovering from another illness I read an interesting piece on Daily Kos. I originally was writing this up as a response to Billmon's excellent article today, Chocolate Covered Cotton. For the record, he makes some very valid points. The whole system is now burnt, and we the average citizen has to pay for what really is fraud on a massive scale. Saying all this, I have to take issue on the idea on the concept of CDOs, Swaps and the entire idea of securitization of loans being total junk. That isn't to say that whats out there isn't toxic, but I'm looking forward.