We have been exposed to a plethora of incomprehensible abbreviations in the last little while.
I am not going to explain what all these financial instruments are in this post. I will be attempting to do that in my "For Dummies" series starting next week.
Collateralized Debt Obligations Have been around for more than 40 years and were originally designed to group large numbers of mortgages together to sell on the bond market.
Credit Default Swaps are about 7 years old and, most simply, are insurance on CDOs.
Interest Rate Swaps - see "For Dummies" to come.
Derivatives. Complicated financial instruments designed to protect businesses and investors from market swings.
We are in such a mess partly because our financial institutions, enamored of the power of these new instruments, stretched their use beyond prudence. As people who have a limited understanding of these instruments, and I include myself, our instinct is to ban their use indefinitely.
Because we don't understand them is no reason to ban them. They all have a purpose - it's that we have yet to define and limit their use. Let's take a look at a financial instrument with which we are all familiar. The word "Mortgage" comes from the two French words "Mort" and "Gage" meaning Dead Hand. Originally The person lending you the money to buy a property had possession of it until you paid it off in full.
Obviously mortgages have come a long way since then.
I once had the task of explaining how mortgages work to Russians who had just arrived in the US. At that time there were no mortgages in Russia. Something simple to us was utterly incomprehensible to them. I suspect that we are all at the stage of those Russians with these new financial instruments and we, or our children, will wonder at our previous lack of understanding of their workings and apprehension at their use. Please support our legislators in making these things work.
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