John “Mac” McQuown yanks on a chain and hoists open a metal roll-up door with a clang. In a flowery aloha shirt, shorts and sandals, he looks like a retiree with little more on his mind than sipping a mai tai by the pool. But McQuown is actually one of the architects of the modern investing system, and he’s far from retiring, Bloomberg Markets magazine will report in its March issue.

“Come here, I want to show you something,” he says on a sunny afternoon in California’s Sonoma Valley.

He steps inside a workshop filled with band saws and other woodworking tools. A gnarled tree trunk the size of a sofa has been cut down the middle lengthwise, revealing ribbons of grain beneath its bark.

“I’m going to make a table out of that,” says McQuown, 80, in the down-home cadence of his Midwestern roots.

A mechanical engineer, McQuown likes to make things at Stone Edge Farm, his 16-acre (6.5-hectare) estate nestled between two mountain ranges north of San Francisco.

In his metal shop, he machines parts for the natural gas- fired microturbine he’s installed in the compound. Rows of cabernet sauvignon vines hang heavy with ripening purple fruit destined for his winery. He even keeps hundreds of thousands of bees to make his own honey.

Yet what McQuown truly loves to create is something that can’t be seen, heard or tasted. He’s a financial engineer, a maker of methods and instruments that enable investors to exploit what he likes to call “distortions” in the capital markets.

‘Exchangeable Bond’

His latest handiwork is a hybrid security that embeds a credit-default swap, the derivative that helped push the global financial system to the edge of ruin in 2008, in a corporate bond.

By joining the two securities into an instrument called an “exchangeable bond,” or eBond for short, McQuown says companies will be able to transform junk-graded debt into the equivalent of AAA-rated notes.

And he’s hoping it will help him take advantage of possibly the biggest imbalance he’s seen in a career that stretches back to the dawn of quantitative investing -- a looming liquidity crunch in the $8 trillion U.S. corporate bond market. McQuown says reinventing the corporate bond to make it less risky should make it easier to trade.

“The market is bumping into its own boundaries,” McQuown says, “and this has created a necessity for solutions.”

‘Market in Flux’

McQuown is bringing out his “synthetic” instrument as years of near-zero interest rates have thrown the debt market into flux. Since January 2009, corporations have issued $7.2 trillion in U.S. dollar-denominated bonds, a 39 percent jump over the prior six years.

Meanwhile, new U.S. and international capital requirements have forced JPMorgan Chase & Co., Bank of America Corp. and other banks to reduce the risks on their books. Wall Street’s primary dealers used to stockpile bonds so they could instantly match buyers and sellers.

Now, they’ve whacked their supplies of fixed-income securities by 76 percent, to $55 billion as of Jan. 5 from about $250 billion in 2007.

The result: an unprecedented gap between outstanding bonds and available liquidity in the world’s No. 1 source of capital for corporations.

‘Long Bull Run’

“That’s dangerous,” says Daniel Gallagher, a commissioner with the U.S. Securities and Exchange Commission. “We’ve had this long bull run in the bond market, but what happens when interest rates rise and there’s more pressure to sell than to buy? Liquidity could dry up, and that could make it harder and more expensive for companies to issue new bonds, and that could impact the broader economy.”

The eBond joins a wave of exotic new securities that are hitting the capital markets seven years after the crash.

Intercontinental Exchange, or ICE, in Atlanta, for example, has introduced futures based on CDS indexes. And Amundi SA, a Paris-based asset management firm, is one of many companies plying investors with automated “smart beta” exchange-traded funds designed to beat the market with little or no increase in fees.

“There’s a lot of action, a lot of experimentation, in the market now,” says Josh Galper, the managing principal of Finadium LLC, a finance research firm based in Concord, Massachusetts. “But innovation does not always reduce risk — it just moves it around.”