Financial derivatives

Alex Tabarrok's post on what's wrong with structured finance and its implications for the financial crisis is a must read. I'd wager it explains up to 40% of what went wrong with the financial crisis. Basically people created AAA securities out of mortgages that were not AAA.

There was also this related gem in the comments:

AAA targets a 1 in 10k chance of default, the classic 'act of God'. People who model these things should anticipate temporal volatility in the mean default rate of the underlying collateral that is lognormally distributed. They didn't.