There's nothing inherently wrong with debt-backed securities. They can be a very healthy part of an economy. Variations of debt backed securities have been around for centuries.

The real problem is the maturity mismatching, which in this case was fraudulent.

Here's how it works:

I put cash in a money market fund. The fund promises me that it only invests my money in very safe short term debt, It promises I can get my money back at any time, on demand. The Sentinel money market fund - to pick a random example - promised that 50% of its investments were overnight loans.

The trouble is that Sentinel lied. It turned out that 80% of their holdings were in long term bonds, and only 8% were in overnight loans. The average maturity date of their holdings was an astounding 32 years. Other money market funds had their money invested in securitized student loans, mortgages, corporate bonds etc.

When you mismatch maturities like this, it becomes a license to print money. The fund accepts my investment. It then loans my dollar out to someone who wants a mortgage. That person pays the builders of the home, who then deposit the money back in the money market fund. The money market fund then loans the money back out again. The cycle keeps repeating, like a great big money printing machine.

This manufacturing of money is what caused gold prices, oil prices, stock prices, and real estate prices to take off over the past five years. More dollars floating around chasing the same quantity of assets causes prices to rise. It also explains the rise in consumer debt. With high inflation and low interest rates, borrowing lots of money is rational. This also explains why the financial industry was responsible for 50% of all American corporate profits in 2006.

At some point, some event causes depositors in the money market fund to get spooked. Perhaps information comes out that a money market fund has too many defaulting loans. The CFO of a VC backed startup is counting on that money to meet payroll in the next few months. He can't afford to accept any risk, nor any delays in redemption. So he decides to withdraw from the fund immediately. Except the CFO of many other companies have the same idea. The money market fund does not actually have the money to pay them. All the fund has is a bunch of IOU's saying, "we will pay you back with interest in 30 years." But the CFO's need the money now, not 30 years. The money market fund is forced to liquidate the IOU's for pennies on the dollars. Everyone loses their shirt. Worse, many businesses were counting on the low interest rates created by maturity mismatching. As people withdraw from money funds, the loan market dries up, and debt financed businesses start to go bankrupt.

This hardly is some "new economic phenomenon". Maturity mismatching has been at the heart of every single systematic financial crisis in the history of the Anglo-American financial system. The most notorious case was the Great Depression.

In the current crisis, the last step - the liquidation of the money market funds - has not happened. That's because Ben Bernanke is a student of the great depression, and recognized what was happening. When the bank run on the money markets began a few months ago, he decided to guarantee all the money market funds with full faith and credit of the government. He was basically saying, "We know that financial industry has been counterfeiting for decades. Unfortunately, now everyone is holding these counterfeit notes, including good, solid businesses. So instead of considering these bills counterfeit and allowing to a financial apocalypse, we're just going to consider these notes legitimate legal tender."