In reality, many of the new products were so specialised that they were never traded in “free” markets at all. An instrument known as “collateralised debt obligations of asset-backed securities” was a case in point. This gizmo turned up in the middle of this decade when bankers created bundles of mortgage-linked bonds, often intermingled with other credit derivatives. The alphabet soup of abbreviations this generated was often as baffling as the products that the acronyms represented. In 2006 and early 2007, no less than $450bn worth of these “CDO of ABS” securities were produced. Instead of being traded, most were sold to banks’ off-balance-sheet entities such as SIVs – “structured investment vehicles” – or simply left on the books.

There’s no market if there are no trades. That’s the donnybrook we find ourselves in now as the banks (with the aid of Geithner and Obama) refuse to sell their junk assets at prices the market has set—because it would show them to be insolvent. Instead, the banks and the administration cling to the hope that these assets will come back into favor, at much higher prices—something that’s just not gonna happen.

Interestingly, Tett reports that even the computers could hardly keep up with the complexity:

The result was that a set of innovations that were supposed to create freer markets actually produced an opaque world in which risk was being concentrated – and in ways almost nobody understood. By 2006, it could “take a whole weekend” for computers to perform the calculations needed to assess the risks of complex CDOs, admit officials at Standard & Poor’s rating agency.

She then writes about how the downward spiral began, as investors realized the computer models and ratings agencies they’d relied on had been horribly wrong. And here’s the lesson:

But the brutal truth is that until financial markets live up to their name – becoming places where assets are traded and priced in a credible manner – it will be difficult to rebuild investor trust. Not for nothing does the root of the word “credit” come from the Latin credere, meaning “to believe”.

This can’t be emphasized enough. If markets are not transparent and liquid then they’re not really markets at all—they’re casinos. If a product is too complex for mere mortals (see: bankers) to understand, why should it be allowed to be created at all?


Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.