clipped from www.ft.com

The unwinding started, as we all now know, in the US subprime housing market. Defaults started to increase in late 2006. The banks weren’t worried at first. Their models assumed that the pinprick default points all over the US were not correlated. But the defaults kept coming. By early 2007, it was clear that the US subprime market had a problem and by that summer, homeowners all over the US were defaulting on their mortgages. The cheap debt made available by the finance revolution was so cheap, in fact, that the loans should never have been made. And the correlation model was still mapping the housing market as it had been in 1990s, not the grossly inflated monster it had become. The development of the model had, ironically, changed the nature of the reality it was modelling.