What they were doing was, they'd take a bucket of high risk mortgages and apply a contract to them to retroactively sort them. So, if you bought the 30th percentile of the bucket and then anything more than 70% of the people in the bucket paid their mortgages you would get paid, and if fewer than that did then you wouldn't.
Then they were rating the highest percentiles in the bucket as AAA because even for borrowers with bad credit, the probability that such a high percentage of them would default was considered very low. Even for people with bad credit, default rates are usually only something like 10%.
But that doesn't work out if you haven't noticed that banks have stopped caring about the default rate when issuing mortgages.
What they were doing was, they'd take a bucket of high risk mortgages and apply a contract to them to retroactively sort them. So, if you bought the 30th percentile of the bucket and then anything more than 70% of the people in the bucket paid their mortgages you would get paid, and if fewer than that did then you wouldn't.
Then they were rating the highest percentiles in the bucket as AAA because even for borrowers with bad credit, the probability that such a high percentage of them would default was considered very low. Even for people with bad credit, default rates are usually only something like 10%.
But that doesn't work out if you haven't noticed that banks have stopped caring about the default rate when issuing mortgages.