Even a Ph.D. in economics doesn't ensure that someone can figure out what's going on in the markets these days.
The National Association for Business Economics survey, released today, found that 51% of those responding had little or no familiarity with the "structure, activities and risks" associated with collateralized debt obligations, or CDOs. CDOs are securities backed by pools of bonds, loans or other assets that are sliced into "tranches" (French for "slice") with varying maturity dates and differing degrees of risk.
A smaller 45% didn't have a good grasp of hedge funds — investment vehicles that are privately run, overseen by investment managers, and not widely available to the public. They use a wide array of investment strategies.
And 68% didn't have a handle on credit default swaps — which investment giant Pimco explains in a bond basics primer as: "In its most basic terms, a credit default swap is similar to an insurance contract, providing the buyer with protection against specific risks."
"There was a joke going around: 'What do you get when you cross a CDO salesman with a Mafia don? You get an offer that you don't understand,' " says Carl Tannenbaum, NABE president and chief economist at LaSalle Bank/ABN-AMRO in Chicago.
Just because they are complicated, doesn't mean that the innovations in finance are bad. But financial firms need to do a better job of explaining them, he says.
The survey ran July 24-Aug. 14, though most were completed by Aug. 4, ahead of much of the market gyration. Still, they show that even before the bottom fell out of the credit markets, concerns were mounting. More than 29% of the economists call the recent housing boom a "serious national bubble," up from 14% in August 2005.
Further, 64% now call "easier credit standards" the No. 1 or No. 2 reason for the housing surge, up from 34% in 2005.
The majority of NABE members said recent, tighter federal mortgage rules — such as making sure borrowers can repay adjustable-rate mortgages at the higher, reset level, not just an initial teaser rate — are appropriate. But 90% termed them "a little late."
And bad credit has supplanted terrorism as the gravest immediate risk threatening the economy, the group said.
Borrowers' withering ability to pay their bills and the subsequent fallout in the credit markets this summer topped the list of short-term risks on peoples' minds, according to the survey.