CDOs are not, strictly speaking, derivatives (well, except for the synthetic variety). The thing about CDOs is that it is very likely that most of the Notes they issues are still intrinsically fine, but they cannot be properly valued. Since the notes were issued in tiers, even a 3 or 4% default rate in the underlying mortgages (and other loans – franchise, student loan, auto, etc) should only touch the bottom couple of teirs – though there are no doubt a few particularly unlucky CDOs out there with an abnormally high concentration of defaults.

For origins of much of the sub-prime mess, look at the crusade against “red-lining”, though obviously the Fed’s easy-money regime also played a large role.