On credit, CDOs, SPVs, credit swaps, and mark-to-market: A Bedtime Story

Once upon a time there was a merchant in Hong Kong who sold sardines along with many other things. Ever filled with schemes and ideas and plans to make more money, one day he packaged mud into a sardine can. He sold the can to another merchant, who added on his own brokerage fees and profits and sold the can to another merchant. The sardine can was passed along in this fashion from merchant to merchant, its cost growing as each made money while passing the can along to the next.

The fifth merchant opened the can and discovered to his dismay that the can was filled with mud instead of sardines. Indignant, he confronted the original merchant with his discovery.

The first merchant replied, “Why did you open the can?”

(cross-posted from subterrain)

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