Risk is unknown ex ante. Nobody knows the value of it. It is the responsibility of those buying the risk to have an estimate and price the security accordingly, ahead of time.
They mixed mortgages which were extremely unlikely to be repaid into packages with enough AAA rated mortgages so that they would meet the credit-rating agencies policy of rating mixed packages as AAA if a certain proportion were AAA.
However, these bonds would be valueless if any of the securities that made them up defaulted.
They sold the packaged bonds a AAA-rated securities without disclosing the likelihood that they would default.
Yes, this was stupid of the ratings agencies
Yes, the buyers should not have bought things they didn't completely understand.
But GS deliberately obfuscated the nature of what they were selling.
Risk is unknown ex ante.
That isn't entirely true. On this example specifically, it's pretty easy to see that if a household can just afford mortgage payments at a discounted rate it is pretty likely they won't be able to afford it when the discounted rate expires.
They mixed mortgages which were extremely unlikely to be repaid into packages with enough AAA rated mortgages so that they would meet the credit-rating agencies policy of rating mixed packages as AAA if a certain proportion were AAA.
There is no such thing as a AAA mortgage. AAA is a rating for bonds and other fixed income securities.
However, these bonds would be valueless if any of the securities that made them up defaulted.
This is not how a CDO works.
They sold the packaged bonds a AAA-rated securities without disclosing the likelihood that they would default.
Why don't you show us the CDO prospectus you allege doesn't do this? Once you produce it, I'll show you the exact (mandatory) table where it's done.
Your comment is the financial equivalent of "The NSA is hacking my pixels in order to break the rot13 encryption." The words kind of suggest computing/finance, but anyone who knows what the words mean recognizes that the content is nonsense.
>They mixed mortgages which were extremely unlikely to be repaid
This is an easy claim to make after the fact.
>However, these bonds would be valueless if any of the securities that made them up defaulted.
Not true at all. The bonds didn't become valueless. In fact, many of these bonds were purchased by the Fed, who made money off them. The issue was CDS' being triggered on defaulting mortgage bonds.
>They sold the packaged bonds a AAA-rated securities without disclosing the likelihood that they would default.
Did they not? Have you read the prospectus'?
Look, I'm sure there were many criminal actions here. But the uninformed, populist overreaction to the financial crisis by people who are unwilling to take personal responsibility is sad.
BUT - and this is pretty important - the ratings agencies were negligent in their rating methodology. Intelligent buyers could see the problems.
The book The Big Short covers this in some detail.