Re: the “magic” of tranches
In plain language, “tranching” meant that a given pool of dodgy mortgages was sliced into pieces from the most- to the least-protected. It also followed that once the inevitable defaults began to roll in during the next recession, the lowest-rated tranches would take the first hits. Considering the increasingly toxic credit characteristics of mortgage lending during that era — “Liars” and “Ninja” (No Income, no job, no assets… no problem) loans, and negative amortization mortgages, plus the very widespread use of ARMs — it didn’t take a financial wizard to realize it wouldn’t require much of an economic downturn to totally nuke the riskiest tranches. This is precisely what happened.
Re: the Fed’s missed chance to stabilize financial markets, a lesson it learned and applied in 2020
The Fed’s response to the pandemic panic would move this from the counter-factual to the proven. In late March of 2020, during the worst of the Covid-driven market collapse, the Fed announced it would buy corporate bonds, including those with a junk rating. Befitting its new operating style, it would do it with funds it just willed into existence. This immediately put a bottom in for the stock and corporate bond markets, triggering one of the fastest and most powerful rallies ever seen. As discussed in Chapter 5, this validated one of my most controversial predictions.