The Bond Market's Shaky Foundation

It's becoming increasingly clear to bond market professionals that an unfortunately large percentage of their peers didn't have a clue what they were doing as they ramped up to take advantage of the boom in the market for corporate debt. In the U.S., 2006 was a record year for corporate debt, with $1.05 trillion in corporate bonds issued, 40% above the level for 2005. The rest of the world kept pace: In China, 2006 set a record with $13 billion in corporate bonds issued, and 2007 started out on a pace to double that total.

Wait! There's More

Corporate bonds were just the tip of the global-debt-market iceberg in 2006, however. The big action was in derivatives, packages based on bonds (derived from them, so to speak) that sliced and diced risk to lower corporate interest bills and to give investors, such as insurance companies and pension funds, investments tailored to exactly the risk and reward needs of their portfolios.

Derivatives based on bonds and loans climbed by $15 trillion in 2006, a 100% increase over 2005, according to the Bank for International Settlements. (The total derivatives market, which includes derivatives based on commodities, currencies and stocks, climbed to $415 trillion in 2006.)

But did every bank or investment house that looked for a piece of the profit from this boom know what it was doing? Not a chance.