There's a time bomb ticking in the markets. Chances are you won't be able to find it.
Even if you do, you probably won't be able to understand how it works, let alone defuse it. Wall Street makes it that way on purpose.
So says Frank Partnoy in his new book Infectious Greed: How Deceit and Risk Corrupted the Financial Markets.
Partnoy recounts every financial crisis that erupted since 1990 and concludes: "Financial innovation and derivatives were at the centre of these crises, and the proliferation of unregulated financial instruments contributed to the problems and exacerbated their effects."
Partnoy, a professor of securities law at the University of San Diego, translates what happened and why into plain English. He then makes a series of recommendations to fix the problem. Topping his list is: "Treat derivatives like other financial instruments", so that investors do not engage in "regulatory arbitrage".
Among his other recommendations are: eliminate the "oligopoly" of credit rating companies; prosecute complex financial fraud; encourage investors to bet against companies; and discourage passive, buy-and-hold investing.
His first book F.I.A.S.C.O. had its funny moments as Partnoy described his experiences in the strange land of Wall Street. But there is nothing funny about Infectious Greed. It is serious, unrelenting and not a little angry.
Who's Partnoy angry at? For starters, he's angry with those who put together derivatives transactions that emphasise complexity and high margins over customer needs. He details case after case where their bosses, let alone the investors who bought the stuff, could not figure out what was going on.
"Not surprisingly," he writes, "traders who were consistently designing transactions to avoid legal rules - and who were paid millions of dollars for doing so - developed a culture of supremacy and disdain."
Partnoy is especially angry with the credit rating agencies.
"Anyone looking closely at the agencies would find it difficult to justify their importance. The analysts at the three rating agencies were ... not, to put it charitably, the sharpest tools in the shed. Banks snapped up the best analysts, and the funds hired the second best.
"Not only had the agencies given Orange County and Pacific Gas & Electric their highest ratings just before those entities became insolvent, they more recently had given high ratings to Enron, Global Crossing, and WorldCom - and stuck to those ratings until just before the companies filed for bankruptcy."
Partnoy is also extremely critical of the regulators, who consistently opposed new laws governing derivatives. "The problem was that when similar financial instruments were regulated differently, parties were encouraged to use the less regulated version to hide risk or to manipulate financial disclosures.
"As long as 'securities' were regulated, but similar 'derivatives' were not, derivatives would be the dark place where regulated parties did their dirty deeds."
His book comes out just as what one thoughtful regulator described for me last week as "the perfect storm" brews up for municipalities.
US municipalities need money. Treasurers' offices no longer function merely as fiduciaries; they are also looked on as little profit centres.
Wall Street is, of course, there to help with swaps, options and derivatives, most of which carry unfathomable risks. The temptation to enter into these transactions and get the cash is powerful. This is, then, the perfect storm. - Bloomberg