Now Entering Russ's World
As with nuclear power, machine guns or capitalism itself, many things that are invented to solve difficult real-world problems and confer great benefits on society eventually show their potential for extreme abuse and harm. This has certainly been the case with many financial instruments. Since the late 1970s, the United States economy has, to an incredible extent, been completely financialized. Whereas prior to 1970, the financial sector only made up a very small percentage of total corporate profits, by the year 2015, corporate profits were more than 50 percent accounted for by financial institutions alone.
This incredible expansion of the role that financial capital plays in the modern economy has led to significant problems. One of these has been the tendency of Wall Street and the financial business in general to innovate. An example of a series of major financial innovations that eventually led to a severe collapse of the global economy was the invention of collateralized debt instruments and the subsequent creation of the credit default swap market in the mid-2000s. By the time of the housing crisis of 2008, trillions of dollars of credit-default swaps were left outstanding, effectively insuring collateralized debt obligations that were mostly made up of junk.
In the early 1990s, James Dondero, the CEO of Highland Capital, realized that many of the banks with which he was doing business were running into the hard wall imposed by capital requirements on bankers. These banks simply did not have the liquidity to make all of the loans for which there was demand, causing serious shortfalls in the ability of creditworthy corporations to acquire short-term funds.
Dondero invented what he called a collateralized loan obligation, a package of short-term corporate loans that could be bundled together and sold to investors as a sort of limited liability corporation. The idea worked. Dondero was hailed as a great financial innovator.