In this case also, I can increase my return with an inflated appraisal and decrease my investment by declaring the risk to be minuscule - meaning rated AAA by widely acclaimed rating agencies.
We can now change another assumption. Assume the playing with matches problem is removed and a new problem is substituted. A problem like the husband and wife both having low-paying jobs and no health insurance, coupled with knowledge that many employers refuse to accept illness as a legitimate reason for missing work and have iron-clad policies that require ill workers be fired for failing to report to work.
Or assume both husband and wife have no seniority and work at jobs that may not exist tomorrow because they were shipped overseas last night.
If I knew one or both of them were developing health problems or that one or both were at risk of being laid off, I would see a reasonably good shot at "winning the disaster lottery" so to speak, by buying mortgage default insurance, also known as a credit default swap, on their $400,000 house.
Then I could sit back, relax and wait for the hoped-for and expected misfortune, which will be my good fortune. As could 99 of my gambling buddies.
Back to the neighbor's home that mysteriously burned to the ground. This tragic event is a great deal for me and my 99 gambling buddies. Our biggest risk is that, having paid the insurance premiums, the home stubbornly refuses to burn to the ground.
Being capitalists, we desire to increase the odds that a disastrous fire will occur. My friends and I with fire insurance policies on my neighbor's house have two options for increasing the odds. One, teach the young child the joys and wonders of paying with matches in closets. Two, hire a professional arsonist.
Holders of credit default swaps have similar but more numerous and less risky opportunities to increase their odds of "winning the disaster lottery".
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