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— The meek have not yet inherited the earth, but the nerds have taken over the world's financial system. Without meaningful reforms, the meek should refuse their inheritance, according to a superb new book, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, by Frank Partnoy, University of San Diego professor of law.

In 1997, Partnoy penned a best-seller, F.I.A.S.C.O.; Blood in the Water on Wall Street, a devastating exposé of derivatives, those bewilderingly complex financial instruments whose value is linked to, or derived from, some other security, such as a stock. In the 1980s, some Wall Street firms realized that there could be infinite variations on the theme -- all concocted to rape clients and rake in loot.

Bring on the nerds. A few firms began hiring physics and math PhDs and chess masters to conceive and sell incomprehensibly complicated financial instruments, which would "rip the face off" their customers, the nerds joyfully explained, picking up Wall Street's insatiable greed and inimitable jargon.

One old-timer dismissed a competing firm as "a techno-loony bin of crazed nerds." The nerds were called "guys without girlfriends."

But those guys without girlfriends were spawning a revolution that would initially enrich Wall Street while screwing the public and then lead to a spectacular collapse. "The markets have been, and are, spinning out of control," writes Partnoy.

Every jackleg bunco artist knows that contrived complexity is the essence of financial fraud. Since the 1980s, the world's financial system has been morphing into a gigantic bunco parlor.

Financial instruments become more and more complex, basically to avoid regulation. Regulators are understaffed and underpaid. "A regulator making $100,000 will never catch a banker making $5 million," says Partnoy in an interview.

Soon, corporations picked up the beat, using financial engineering -- including derivatives and phony accounting ploys -- to manipulate earnings. Sophisticated investors couldn't cut through the haze. Top managements couldn't comprehend the concoctions of supposedly subordinate nerds.

All this played right into the hands of the move toward deregulation. In theory, free-market forces would protect the public interest. But thanks to the contrived complexity, many of those markets were rigged.

Federal Reserve Chairman Alan Greenspan complained of "infectious greed" but insisted that people are not greedier. Ripostes Partnoy, "People get greedier at certain times, and this is one of those times."

Chronologically, Infectious Greed traces the billowing piggishness. We see Orange County taken to the cleaners by derivatives. (San Diego dabbled in derivatives exotica too.)

We see consumer products maker Procter & Gamble fleeced and befuddled by derivatives. P&G's chairman called underlings who had purchased the instruments "farm boys at a country carnival."

The book moves seamlessly from derivatives to grossly excessive CEO pay and to initial public offerings of the late 1990s that, on average, zoomed more than 70 percent the first day -- the result of manipulation.

San Diego's MP3.com, producer of downloadable digital music on the Internet, went out at $28 and closed the first day at $63. It shot to $105 but then was hit with copyright infringement lawsuits. It was eventually bought for $5 a share.

The firm that handled MP3's underwriting, CS First Boston, was doling out shares in many hot IPOs to customers who would then pay the firm enormous commissions for stock in unrelated companies. Those are kickbacks, but the government dropped a criminal investigation of the firm, which settled for $100 million -- chump change.

Global Crossing went public in 1998 and soared. Big enchilada Gary Winnick, former handmaiden of once-imprisoned 1980s takeover king Mike Milken, managed to dump $735 million worth of Global Crossing stock, thus qualifying for the "the Greedy Bunch" featured in the September 2, 2002, Fortune magazine -- five executives who massively jettisoned stocks that later plunged. Another of the five was San Diego's John Moores, who sold off $646 million of Peregrine shares before the collapse.

The book cogently explains infectious accounting abuses. Half a century ago, accounting was fairly clean. By the peak of the bull market in the late 1990s, the bluest of blue chips were stretching accounting conventions, knowing that regulators would look the other way. "If the gain from cooking the books is substantial, and the probability of punishment is zero, the rational strategy is to cook, cook, cook," writes Partnoy.

It took the bear market to get the feds to pursue accounting fraud. But last year's criminal cases "did little to persuade market participants that the probability of punishment for complex financial fraud was anything other than zero," writes Partnoy.

Ditto civil lawsuits. Partnoy says that the most-feared tort lawyer, San Diego's Bill Lerach, was slow to tackle derivatives, concentrating on simpler fraud.

Lerach is now lead prosecutor in Enron civil suits, and Enron is "incredibly complex," says Partnoy. In reality, Enron was a derivatives-trading firm. Those derivatives were extremely profitable, masking huge losses in other misadventures.

Enron used fanciful accounting but revealed its machinations in "garbled and opaque" financial statements, Partnoy writes. Its actions weren't illegal, but alegal.

Shamefully, "dozens of other companies were doing the same kinds of deals," he says. Apologists blame a few bad apples. But, writes Partnoy, "There was a cultural change among corporate executives during the 1990s....The apples fell because the tree was rotten."

Partnoy suggests many reforms. The $100 trillion of derivatives should be treated like other securities -- that is, regulated. The gatekeepers -- accounting and law firms, banks and credit-rating agencies -- should be forced to reform, particularly since they have done such an abysmal job policing their corporate clients.

The government must prosecute complex financial fraud. If there aren't sufficient reforms, "We will continue to have these huge surprises, massive losses," says Partnoy. "Complexity has been growing exponentially and reforms are not coming." The Sarbanes-Oxley purported reform bill "had one section requiring more disclosure for derivatives, and the Securities and Exchange Commission has already scaled that back."

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