Wired explains the “formula that killed Wall Street.”

Basically, the Li’s Gaussian copula function was too simple. The formula turns correlation, something that varies and is nearly impossible to determine, into a single constant. Not only that, the correlation measured isn’t even based on the underlying mortgages, but rather between prices of credit default swaps as determined the market, which prices these swaps based on the correlation. It’s like an extremely sophisticated way of begging the question. And, there’s more:

… because an unlimited number of credit default swaps can be sold against each borrower, the supply of swaps isn’t constrained the way the supply of bonds is, so the CDS market managed to grow extremely rapidly … At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion.