Derivative volumes remain high. Structured investment products are booming. Structured credit, such as collateralised loan obligations, has recovered to pre-crisis levels. Shadow banking volumes are high, proliferating into emerging markets. In a market priced for perfection, compensation for risk is inadequate.

Low returns and the need for income are driving the dash for trash. With returns low, leverage amplifies small potential gains. Low borrowing costs encourage carry trades or structures with embedded leverage.

Even governments have resorted to financial engineering. The EU used loss allocation techniques from structured credit for its original bailout fund and now for its new Infrastructure Investment initiative. The European Central Bank is promoting securitisation to increase outstanding asset backed securities to facilitate its policies. To recapitalise banks, regulators have approved risky hybrid securities, such as contingent capital and bail-in bonds.

In 2008, these financial products proved problematic. They accentuated leverage. They were complex. Opaque networks transmitted shocks rapidly and unpredictably. The market was highly concentrated among a small coterie of dealers. There was limited understanding of the products and risks. The issues remain.

Intervention in markets has created anomalies encouraging investors to take risks on forward rates, volatility and correlation. Guidance that policy rates are unlikely to normalise soon encourages investors to take positions against market forward rates anticipating a quicker pace of tightening. Lower volatility, resulting from policy actions, leads investors to bet on continued benign market conditions to boost returns.

The three Cs of financial product regulation have been capital, central counterparty (CCP) and collateral. Extra capital, while welcome, will transmit losses in the event of a systemic crisis to insurance companies, pension funds and private investors. Bailing them out may be politically necessary or expedient. CCPs have added complexity, creating new nodes of concentration and instability. CCP risk management is unproven under conditions of stress. New exposure arise from only some but not all products being cleared, the need to channel deals through a small group of clearing members and the clash between national CCPs and cross border trades. Collateral places excessive reliance on government bonds whose quality is falling.

Simpler solutions have proved politically difficult. The problems of derivatives could be decreased by reducing the size of the market, limiting transactions to only insuring pre-existing financial risks. Limitations on collateral and transactions with shadow banks would minimise contagion. Restricting the use of certain products, as with narcotics, were not considered. Products bad for your wealth, it seems, are different to products bad for health.