Since it is chillingly clear that U.S. financial institutions have for a good while been regulated no more stringently than, say, demolition derby drivers, Washington has belatedly locked the garage door and begun to debate strict new rules. The blueprint at hand is President Obama’s sweeping proposal in mid-June to revamp the responsibilities of government agencies and impose new regulations on the financial establishment. Nothing about this plan will fall easily into place: Too many government agencies will dig in their heels. Too many financial companies will battle every aspect of reform that threatens their bottom lines.

Inevitably the center of controversy is going to be the complex instruments called over-the-counter derivatives. These are contractual arrangements between two parties—at least one of which is likely to be a giant financial institution that transfer risk. They typically have notional values (par values, essentially) in the millions of dollars, are often long in duration, and go by such names as swaps, forwards, and options. And they are, not incidentally, a source of lush profits for banks.

Perhaps for that reason, it is the amazing contention of some in the financial world that derivatives sailed quite smoothly through the financial crisis. One banker said recently that the derivatives problem at AIG was mainly that management wasn’t paying attention.

This article will present a different view. We’ll start with re­minders of how derivatives contributed to the collapse of Bear Stearns and AIG, in the process delivering a large, and detested, bill to the U.S. taxpayer. We’ll also go behind the scenes of the bankrupt Lehman Brothers, whose 900,000 derivatives con­tracts are proving once again that the sheer complexity of these instruments is itself an enormous problem. So is regulating them, which does not mean we shouldn’t be trying.