This was the beginning of the heyday of hedge funds. Unregulated investment houses were originally based on the questionable but legal practice of short-selling—selling a financial instrument you don’t own in hopes of buying it back later at a lower price. That way, you hedge your bets: You cover your investment in a company in case a company’s stock price falls. But hedge funds later diversified their practices beyond that easy definition. These funds acquired a good deal of popular mystique. They made scads of money. Their notoriously high entry fees—up to 5 percent of the investment, plus as much as 36 percent of profits—served as barriers to all but the richest investors, who gave fortunes to the funds to play with. The funds boasted of having genius analysts and fabulous proprietary algorithms. Few could discern what they really did, but the returns, for those who could buy in, often seemed magical.

But it wasn’t magic. It amounted to the return of the age-old scam called “bucket shops.” Also sometimes known as “boiler rooms,” bucket shops emerged after the Civil War. Usually, they were storefronts where people came to bet on stocks without owning them. Unlike their customers, the shops actually owned blocks of stock. If customers were betting that a stock would go up, the shops would sell it and the price would plunge; if bettors were bearish, the shops would buy. In this way, they cleaned out their customers. Frenetic bucket-shop activity caused the Panic of 1907. By 1909, New York had banned bucket shops, and every other state soon followed.

About $2 trillion in credit derivatives in 1989 jumped to $8 trillion in 1994 and skyrocketed to $100 trillion in 2002. Last year, the Bank for International Settlements, a consortium of the world’s central banks based in Basel (the Fed chair, Ben Bernanke, sits on its board), reported the gross value of these commitments at $596 trillion. Some are due, and some will mature soon. Typically, they involve contracts of five years or less. Credit derivatives are breaking and will continue to break the world’s financial system and cause an unending crisis of liquidity and gummed-up credit. Warren Buffett branded derivatives the “financial weapons of mass destruction.” Felix Rohatyn, the investment banker who organized the bailout of New York a generation ago, called them “financial hydrogen bombs.” Both are right. At almost $600 trillion, over-the-counter (OTC) derivatives dwarf the value of publicly traded equities on world exchanges, which totaled $62.5 trillion in the fall of 2007 and fell to $36.6 trillion a year later. The nice thing about public markets is that they act as canaries that give warnings as they did in 1929, 1987 (the program trading debacle), and 2001 (the dot-com bubble), so we can scramble out with our economic lives. But completely private and unregulated, the OTC derivatives trade is justly known as the “dark market.”

The advantage of treating these players like racketeers under federal law is that their ill-gotten gains could be forfeited. The government could recoup these odious gambling debts instead of simply paying them off. In finance, the bottom line is the bottom line. The bottom line in this scandal is that fantastically wealthy entities positioned themselves to make unfathomable fortunes by betting that average Americans-Joe Six-Packs and hockey moms-would fail.