A Hybrid That Converts Junk Bonds To Triple A?

Moreover, Jennings is having a hard time persuading chief financial officers to take a chance on using eBonds amid the fixed-income boom.

“No one has a problem raising capital right now,” Jennings says. “The biggest challenge, without a doubt, is overcoming the question of, ‘Has anyone else done it?’”

There’s a bigger problem with the eBond -- and, for that matter, with financial engineering in general -- says Wallace Turbeville, a senior fellow at Demos, a New York–based think tank.

Good Intentions

The bond is a simple instrument with a debtor and creditor that’s proven its utility for centuries. The eBond inserts a third party into the transaction -- the seller of the swap embedded in the security who now bears its credit risk.

Such machinations may be designed with good intentions, but they just further convolute the marketplace, says Turbeville, a former investment banker at Goldman Sachs.

“Why are we doing this? Is our society better off as a result of this innovation?” he asks. “You can’t destroy risk; you just move it around. I would argue that we have to reduce complexity and face the fact that it’s actually good for institutions to experience risks.”

A Balmy Evening

Back at Stone Edge Farm, it’s a balmy evening and McQuown has invited MacWilliams and Jennings to join him and Leslie for dinner at an outdoor table.

The couple’s chef serves a deconstructed eggplant Parmesan salad with heirloom cherry tomatoes and rocket from the farm’s organic garden, and glasses are filled with the 2006 vintage of McQuown’s cabernet sauvignon, which sells in the secondary fine- wine market for $110 a bottle.

As the conversation turns to “complexity theory,” an interdisciplinary approach developed by physicists at the Santa Fe Institute to analyze systems such as the oceans or the brain, McQuown is in his element. For him, the capital markets are an ever-changing machine to be tuned and re-engineered indefinitely.

McQuown’s breakthroughs with index funds and credit-default analysis worked to the benefit of investors. The question now is, will his tinkering do the same as the bond market heads into a crucial transition?

‘Financial Dysfunction’

“There’s going to be a lot of experiments, and more power to those that are trying to figure out solutions,” McQuown says on the phone a few weeks later. “Otherwise, we’ll end up with financial dysfunction, and there’s really no reason for that.”

He’s about to describe an idea for a new type of mutual fund when he has to hop off the call. Someone calls from the gate. It’s a group of researchers from the Institute for the Future, a Palo Alto, California–based group that forecasts social and technological trends. They’re not interested in bonds or CDSs.

No problem. The engineer is happy to show them how his microturbine and solar array will soon shift his entire compound off the grid.