Hey ! Nice to run into someone who actually worked on Magnetar.
At this point I've spent a lot(!) of time trying to express my thoughts, but it keeps over expanding once I start discussing or thinking about social proof and the Salesman analogy -
Let me see if I can create a framework, or at least tease a few distinct strands apart.
1) Qualified Investors: I tend to agree, it seems not many investors know whats going on in the things/CDOs they expose themselves to.
Its a word which carries a legacy meaning that I think needs to be updated, or at least "Qualified Investor" should stop meaning "Patsy".
2) The Car Salesman analogy. If it is describing an ideal of where we should reach, then I think we agree - yes buyers should have genuine ability to decipher the complexity/accurately asses the security. They should have genuine choice between them and other banks. They should not suffer information asymmetries.
This means that we have, at the very least, working rating agencies, strong regulators to enforce rules and break up abuse, among many other prereqs.
3) Social proof - I am not satisfied with my arguments/ability to put it across but here is a rough draft -
Social proof should be working but its not. There are probably a constellation of reasons for this likely -
Lack of choice/competitors in major banks, network and reputation effects enjoyed by the big banks, talent asymmetry, information asymmetry, regulatory capture/weakening.
Social proof, for that people have to have a choice between trustworthy and less trust worthy banks. If all banks are tarnished, then the choice is irrelevant. You end up choosing between different levels of competence and equal levels of avarice. All the car salesman are out to get you, maybe go for a scooter.
There are honestly far too many ways to approach this analogy/point and I would love to get away from it.
4) Finally in your last para you are essentially saying "Caveat emptor".
Come now.
Caveat emptor right now ends up ignoring wall street attitudes, obvious and even proven(! "can you imagine the idiots got caught") malfeasance, industry acceptance of morally agnostic standards, constant and now expected abuse of information/talent/power asymmetries.
I think you will also agree that the letter of the law is seen often as an obstacle course that people have to find the shortest path through. Heck the sheer artistry and creativity in the financial instruments being created is impressive. How many times have you come across a structure and said - wow, nice way to get out of that restriction.
I liken wall streeters to hackers - they like finding imaginative ways they can make their bets. They just don't see it in a moral sense. Its about optimum paths and optimum outcomes. If you plan wrong, you suffer. Your punitive lessons are your losses. The strong survive.
Ok I need a break, I really am hesitant to put this out there, because I can see a few angles of attack, which are arising from an overlap between different portions of finance and because I've generalized/glossed over details in some places. This was done in the interest of not getting too focused/bogged down. Probably needs to be addressed though.