Security design boosted cross-market correlation and turned local losses into systemic collapse.

Evidence

But the real surprise, the amplifier, was that the design of these securities, rather than lessening correlation, actually boosted it. … What was uncorrelated in theory became extremely correlated in practice. Making matters worse were the CDS (insurance) contracts attached to the CDOs that would pay out if the security defaulted. If these insurance claims happened en masse, the insolvency of the entire system emerged as a distinct possibility. So, when the scope of CDS protection both written by and written on Lehman by firms such as AIG became apparent, not only did the markets take fright, the state for the first time began to see the problem as systemic rather than idiosyncratic, and too big to fail became a reality. — Mark Blyth, Austerity, 96

Categorization

• XREF: Directly relevant to Mattei’s argument that austerity begins with the public absorption of private financial losses. — connects to: Correlation assumptions in CDO design collapsed when housing markets proved linked. — Mark Blyth, Austerity: The History of a Dangerous…, 91; Imitation can suddenly raise cross-asset correlations and defeat diversification. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1229; Compressed decision time makes financial markets prone to cascading collapse — David Harvey, The Condition of Postmodernity: An…, 1938 (+4 more)
• SEED: Article angle: securitization as an engineering failure — diversification assumptions turned into contagion vectors.

Broader Connections

• Imitation can suddenly raise cross-asset correlations and defeat diversification. #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 1229
• Fundamentally unrelated market phenomena can suddenly move in lock-step within a global microstructure #expands (0.80) — Donald MacKenzie, An Engine, Not a Camera, 1088
• Compressed decision time makes financial markets prone to cascading collapse #expands (0.75) — David Harvey, The Condition of Postmodernity, 1938