>> It was the hysterical forecast of price appreciation, not the "hiding" of risk (it was never really hidden), that constituted the bubble.
It's not true that risk was "never really hidden."
A very influential quant math model, David Li's "gaussian copula default function," widely used to determine the risk of correlated default on the mortgages underpinning mortgage backed CDOs, played a very significant role in their explosive growth. The formula extracted estimates of this risk from the pricing of their associated CDSs on the "assumption that financial markets in general, and CDS markets in particular, can price default risk correctly."
"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. ... When the price of a credit default swap goes up, that indicates that default risk has risen. Li's breakthrough was that instead of waiting to assemble enough historical data about actual defaults, which are rare in the real world, he used historical prices from the CDS market. ... Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly)." http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
This development itself expressed the increasingly important role quants had come to play on Wall Street. http://www.ft.com/cms/s/2/912d85e8-2d75-11de-9eba-00144feabdc0.html#axzz1WRS2FDnr
Thus the irrationality underpinning CDS pricing became a key determinant of estimates of risk on CDOs. Since this greatly underestimated the actual risk, it itself served to increase it by providing an incentive for the granting of mortgages on which default was practically certain.
It was this hiding of the actual risk that created an opening for what Michael Lewis has called "the big short." http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004 http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom/
Ted