[malandrew]

Not really. OTC derivatives greatly contributed to what happened because it obscured who your counterparty was in a transaction. This is really important because as the world falls apart around you, you don't know if your OTC derivatives happen to be based indirectly and at least in part on some other failing financial institution. Multiply this by everyone you do business with and you have a complete dissolution of trust and ability to properly assess risk. Those institutions that failed and only had vanilla home mortgage loans failed because they themselves were the ones responsible for the irresponsible lending or because they got caught up by it at the end of the unraveling that destroyed enormous amounts of value.

There is no way that the markets would have fallen that far and that fast if most participants, and the rating agencies, had the capacity to accurately and directly determine how much risk they and their counterparties had.

I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling and create an environment where rating agencies feel comfortable playing the tit-for-tat game with banks because they thought no one would notice ethical transgressions among all the indirection of derivatives.

[yummyfajitas]

This is really important because as the world falls apart around you, you don't know if your OTC derivatives happen to be based indirectly and at least in part on some other failing financial institution.

This is simply incorrect. The cash flows involved in an OTC derivative are explicitly stated in the contract itself.

I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling...

You imagine incorrectly. Pricing most of these contracts is 8'th grade math given a specific scenario - fancy math comes into play only in estimating the probabilities of each scenario. In principle, the pricing formula is this:

    price = P(housing goes down) x BIG LOSS + P(housing goes up) x MODERATE GAIN

That's the price, regardless of whether it's a straightforward vanilla mortgage or a fancy synthetic CDO. The ratings agencies, banks and government all assigned a very low value to P(housing goes down). Using vanilla instruments doesn't change this basic calculation.

[sseveran]

In OTC trading by definition you know who your counter party is since you called them on the phone or they called you. What you are really trying to say is that you had no idea whether they had an off setting contract or if they were taking the other side of your position directly. I am not sure the exchange system we have for derivatives now has made things any better.

[onebaddude]

I take issue with the connotation as you describe derivatives; they hide and obscure. They are a tool, nothing more.

Other than that, I agree. It was the lack of a central clearing house for the derivatives -which would have allowed issuers to determine counter party risks and price it properly -that was the failing. But that's a human error. There's no need whatsoever to blame the securities themselves.

[CamperBob2]

Are you thinking of CDSs?