Programming note: Money Stuff will be off tomorrow, back on Monday.
In 2008 the prices of some structured credit products built out of subprime U.S. mortgages went down, and as a result there was a global recession and millions of people lost their jobs. If you had asked a normal person in 2007: “How would it affect your life if it turns out that investors have mispriced the super-senior risk in synthetic collateralized debt obligations built out of subprime mortgage tranches,” that person would have said “I have no idea what you are talking about, but I can’t imagine how that collection of words would affect me.” But it did. Loosely speaking, the mechanism was that the people (often banks or shadow banks) who owned subprime CDOs (1) also owned other stuff and (2) had borrowed money to buy that stuff. When their CDOs collapsed, they had to sell other stuff to pay off their debts, which drove down the prices of other stuff, which led to broad market contagion, which destroyed a lot of wealth, which reduced economic activity, etc. Meanwhile the banks had lost money and were more risk-averse and less able to lend, which also reduced economic activity. And so normal people lost their jobs because of contagion from some weird financial asset that they hadn’t even heard of.