Parts of that is right, but I think you mis-state a lot of the ratings stuff.<p>The fundamental idea behind the ratings is (simplifying a lot) that you could take a lot of crap mortgages and then slice them into tranches, assigning losses to the lowest tranches first, and to the highest tranches last.  So if you have 1000 mortgages, and you slice it into 10 tranches of 100 each, and 250 mortgages go bad, then the lowest two tranches lose 100%, the next tranche loses 50%, and the top 7 tranches lose 0%.  What the ratings agencies were doing by assigning AAA grades to the top tranches was estimating the likelihood that <i>EVERYTHING</i> would go bad was very low.<p>And what I think a lot of people miss about the financial crisis is that <i>this was not wrong</i>.  Not only was it correct in principle, but actual losses on AAA rated securities was extremely low because even among subprime a lot kept on being serviced.  So the ratings agencies said &quot;hell, we could have a massive crisis and these top tranches will still mostly pay out&quot;, and then we did have a massive crisis, <i>and those top tranches still mostly paid out</i>.<p>There were a lot of issues and problems and corners cut and bad paperwork and robosigning and a hundred and one other scandals, some quite significant.  However when you say:<p>&gt; They had assumed that &quot;AAA&quot; would remain relatively safe.<p>It&#x27;s worth remembering that this assumption was shown to be correct!  From the financial crisis inquiry report:<p>&quot;Overall, for 2005 to 2007 vintage tranches of mortgage-backed securities originally rated triple-A, despite the mass downgrades, only [...] 4% of subprime securities had [...] losses imminent or had already been suffered by the end of 2009.&quot;<p>On the other hand, something like 95% of lower rated tranches ended up suffering losses.  The tranches were a mechanism for concentrating credit risk in the lower tranches; the problem isn&#x27;t that it didn&#x27;t work, but that 1) it worked really well and 2) everyone was badly underestimating the total about of credit risk in the system.  AAA was mostly fine; everything short of AAA was absolute <i>toast</i>.<p>(Also, I think you&#x27;re missing how <i>huge</i> the decline in home prices was, both as cause and vector of the crisis.  A vast amount of paper wealth nominally owned by the middle class vanished in a puff of smoke; most of the crisis was the result of that.  But the impacts of an asset price bubble should properly be attributed to its inflation, not it&#x27;s popping.)