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Game Time: Complex Investments Mask Simple Reality

Have at it, Sudoku fans, crossword wizards, devotees of Rube Goldbergian cause and effect -- I present to you a "complex security" of the kind implicated in the U.S. banking crisis. Solve it if you dare.

The diagram, drawn from today's Congressional Oversight Panel report, is as good a visual metaphor as I've seen for the thumb-sucking complexity inherent in turning pools of bank loans into the kind of clinkering, clankering investments used by financial firms to inflate the housing bubble (click on the chart to expand).

That process, securitization, has made a dark comedy out of calculating financial risk and return. And its purveyors often have no greater understanding of these instruments than a monkey has of the internal combustion engine.

Note the arrows pointing this way and that, like directions to some impossible to assemble gadget (step 1: Insert Super Senior Tranche A into Mezzanine Tranche B; do not tighten). Note the sleek "Special Purpose Vehicle" near the center, hinting at the guiltless pleasures of off-balance sheet accounting. It's harder to spot, but within the austere boxes and lines especially look for the fanciful assumption that gave mortgage-backed securities their sheen -- that real estate is now and forever a safe bet.

As with all "perpetual" motion machines, of course, the marbles must eventually come to a rest. The marvelous complexity cooked up in Wall Street's structured finance labs turned out to conceal an even more marvelous simplicity: Sometimes home prices fall.