I know just enough to want to see boobs and cars!
FWIW: There is no "house of cards" to come down, IMO. These swaps are essentially insurance-type vehicles and they are struggling in a few cases due the the double-whammy of an over-heated housing market trying to regain equilibrium and the sub-prime loan losses. No one could have predicted that yet I think it is working itself out nicely. We only have 1% or 2% of mortgage loans in default, and that is a very manageable, albeit regrettable, situation. Just as the housing market excesses have to be worked out, so to do the credit market excesses that accompanied it. But this is FAR from the end of the world as we know it.
All during 06 and until December of 07 that is the same thing you said about the housing and credit market.
You really need to take a look at the numbers and more importantly the ratios.
As for blowing off the 1-2% mortgage loans in default, those number become cumulative, it is not a static number [that same darned 1% being late again for a whole year]. Simply put, if 1% are in default in January that is X number of defaults. That repeats monthly so by the end of the year you have 12X. In the case of the Financial, Credit and Mortgage industries which work off of 1/100 of a percent increments 1% is large. 2% is huge. These folks project their business plans on "up to .25%" failure rate.
It is why they have insurance when things go over throttle. And there is not enough equity in the insurance pool to compensate for the current levels of foreclosures in the Mortgage market and defaults in the Credit Card/Consumer market.
The word you need to understand is "leveraged". When the system is working it is a great way to bundle. When the system fails, it is nothing but a house of cards.