Actual wizard money: worth about as much as defaulted CDOs
Tyler Cowen explains the allure of the financial magic that attracted our financial sector and how minor errors in estimates explode the magical spell:
Suppose that we misspecified the underlying probability of mortgage default and we later discover the true probability is not .05 but .06. In terms of our original mortgages the true default rate is 20 percent higher than we thought–not good but not deadly either. However, with this small error, the probability of default in the 10 tranche jumps from p=.0282 to p=.0775, a 175% increase. Moreover, the probability of default of the CDO jumps from p=.0005 to p=.247, a 45,000% increase!
A bit “mathy” but read it and you will understand how the best intentions (create a bullet proof investment) often go awry. Like so many complicated systems, safety comes from separation and redundancy not aggregation.