The ability to create credit now extends far beyond the reach of the traditional banking system. A revolution is transforming the credit markets, establishing links among borrowers and lenders that previously would have been impossible.

Every imaginable stream of future cash flow — from car and mortgage payments to the loans that fund private equity deals — can be "securitized" and sold to the highest bidder. Securitization is simply the process whereby a stream of future cash flow becomes pledged to a separate legal entity, which then divvies up the cash flow among different "tranches," or classes, of creditors.

The growth of securitization has truly altered the global economy, and most choose to focus only on the positives. But like everything in life, the securitization revolution has its positives and negatives.

One negative consequence is that financial markets are starting to shape the destiny of the real economy, not the other way around. Storied currency speculator George Soros was one of the first to speak publicly about the phenomenon of markets shaping economies. He calls it the theory of "reflexivity" and described it when testifying in front of Congress in 1994:

The generally accepted theory is that financial markets tend toward equilibrium and, on the whole, discount the future correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly, because they do not merely discount the future; they help to shape it [emphasis added]. In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal.

In Soros' view, the judgments and emotions of today's financial market participants can alter future economic fundamentals. For example, as a company's stock grows more coveted by wild-eyed speculators, its cost of capital gets lower and lower as its stock skyrockets; the higher its stock price, the more capital a company can raise in a secondary stock offering by issuing a set amount of shares. So its ability to reinvest capital and grow — its future — is shaped by the whims of speculators.

Another negative consequence of the securitization revolution: The further a lender is separated from a borrower, the more potential there is for fraud on the part of the borrower and underestimation of risk on the part of the lender. Very bad loans tend to be made when this is the case, as those who've dabbled in subprime mortgages are discovering, and the process of discovering just how many doomed-to-fail mortgages were written is far from over. On one end of the lending chain are plenty of fraudulent "liars' loans" yet to default, and on the other are plenty of lenders who don't fully understand the risks they are taking.

Wall Street investment banks like Goldman Sachs and Bear Stearns have long outpaced traditional commercial banks in the race to originate the most profitable loans. Proliferation of CDOs has enabled the best salesmen on the Street to stuff all manner of debt down the gullet of formerly unsuspecting institutional buyers. But ever since these buyers started refusing unfriendly provisions like payment-in-kind (PIK) toggles, investment banks have had to retain far larger morsels of LBO debt than they had planned.

Indigestion tends to lower an appetite, and institutional investors' appetite for junk bonds is spoiling just as Wall Street tries to serve them heaps of acidic securities. While CDOs have shifted risk away from the banking system by linking borrowers with lenders from around the world, they have not lessened default risk; they've merely transferred it to unsuspecting lenders that are just beginning to push back.