Nota bene: I am likely to get many details wrong, caveat emptor.
security - A security is a financial product that pools together contractual debt. Certain kinds of debt are desirable investments; they pay interest rates at varying degrees of interest/risk.
If you are a money manager for some kind of fund, like say a pension plan or a 401k, you may like the risk profile of a certain class of debt, but you can't invest in it directly because you're not in the business of handing out millions of, say, car loans.
So, you talk to an investment bank. An investment bank will buy thousands of loans and, for instance, create a holding company whose sole assets are those loans. You then buy shares in that holding company for $x dollars, and over time – as the debtors pay back their loans - the holding company will issue back dividends until you've made back your investment and the interest.
The securitzation process is seen to diminish the risk of investing in a given kind of loan, and allows people to make bets they otherwise couldn't.
Worth keeping in mind that securities are risk-free for the entity creating them. You create the security, and then you sell it all off and make money by charging a fee. As a result, the incentive structure is often to try to create as many securities as possible.
http://en.wikipedia.org/wiki/Securitization
debt - No one fully understands the nature of debt yet. Certain aspects of its behaviour, iirc, are still up for debate.
mortgage backed security - Securities are often "backed" by an "asset". Mortgages are seen as great for this, since if someone defaults on a mortgage you get the house back. Right up until housing prices began to collapse, a mortgage backed security was seen as a safe bet. Mortgage backed securities were the backbone of collateralized debt obligations.
http://en.wikipedia.org/wiki/Mortgage-backed_securities
collateralized debt obligation - A special kind of asset backed security that combines loans with different risk profiles into "tranches" (french for "slice"). As an investor, you buy into a particular tranche that offers the rate of return you're looking for. The deal is if you buy the "super safe" slice of the security, you accept a lower rate of return in exchange for knowing your initial investment is going to be safe.
CDOs were more or less unused until the 2000s, where investor desire for betting on the booming housing market consumed basically all available mortgages. So, once you run out of safe mortgages - people in middle class jobs buying houses to live in - you create riskier mortgages. These mortgages have higher interest rates but correspondingly they also have a higher default rate.
If you think you can guess the rate at which people default, you can create the slices mentioned above.
Investors were hungry for AAA-super-safe debt, not in the risky stuff. An investment bank could take all these super-risky mortgages at, say, I don't know, 12% and split them into, say, three tranches. The lowest tranche might return 10%, the middle one 7% and the bottom one 4%. Buying into the low tranches meant you accept a higher risk of the investment not panning out and you losing your money, and when people default they are the first to stop paying out. Real CDOs had a dozen or two tranches, iirc.
This is a large component of the 'toxic assets' from 2007 onwards.
http://en.wikipedia.org/wiki/Collateralized_debt_obligation http://www.npr.org/templates/story/story.php?storyId=124578382
ARM, or adjustable-rate mortgages - Mortgages were the interest rate is pegged to a given index instead of being defined as a constant. As CDOs exploded in popularity, the hunger for more mortgages to sell increased. So, for a few years it was ridiculously easy to obtain mortgages. Folks began to sell "balloon" mortgages where the interest rate is low for the first two years but then jumps considerably. This wasn't a horribly dumb idea back when houses appreciated 10-20% per year and people made a living flipping houses.
credit default swaps - is a kind of insurance on your debtors defaulting. Suppose you give out a loan. You can then turn around and insure the value of your loan; basically, an insurance company looks at the loan you gave and says, "for $y a month, if your debtor fails I will pay you back the value of your loan".
I had to bring up a CDO before a CDS because CDS' were used to make CDOs look like a good investment. Of course it's safe! Not only do property values never decline - so the underlying loan always bounces back with something - but we also have all this insurance.
Credit default swaps is how mortgages securities threatened the entirety of the economy. It turns out that CDOs are computationally intractable ( http://www.cs.princeton.edu/~rongge/derivative.pdf ); unless you're the person who put it together, it's very hard to impossible to accurately judge their risk profile.
Better yet, you don't have to own the debt to take out insurance on it. CDS' were used by people who believed the market was about to collapse to make an insane killing and, in a few cases, used fraudulently by the investment banks selling the CDOs. See http://www.propublica.org/article/all-the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble for an example.
This is the core of my comparison. These instruments make risk impossible to judge.
For more, see http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-pool-of-money
retail investor - You or me. People who are not investment professionals. The opposite of an accredited investor - http://en.wikipedia.org/wiki/Accredited_investor
In order to play in the market offering CDOs and CDS', not only do you have to be an accredited investor, but you also had to have hundreds of millions of dollars under your control. As patio11 pointed out, the most people like us could do was either take out a mortgage or buy shares of the companies involved. Or if you have only a few million dollars in your control, maybe buy directly into the hedge funds involved.
crowdfunding startups - a "crowdfunded" startup is a web 2.0 way of describing securitized venture capital investment, where the investors don't have to be accredited (this is new, via the JOBS act). It's not like accredited investors compose a smarter class of people; they are however supposed to be "savvy" (i.e. they know the rules of the game) and perhaps more importantly, have enough money such that they're unlikely to be totally ruined if their high-risk investment goes south.
I, obviously, think crowdfunded startups are probably a horrible idea. It's appealing in the kickstarter sense - greater democracy in credit markets, and a promise of escape from the current "old boys network" venture capital investments currently operate in. That aspect is appealing.
However, startups are incredibly risky and are basically a crapshoot. It's impossible to accurately weigh in the risk and, further more, their shares do not operate in a liquid market - if you own 1,000 shares of a moderately successful small to medium company, there is no one you can sell those shares to. Your choices are to wait for Google to buy them, wait for them to grow huge and go public or sell them back to the company at a discount.
Right now, the fact that the startup market is overheated (albeit some signs indicate that post FB IPO the bubble has deflated somewhat) is somewhat harmless. Rich people are just throwing money at the wall. It becomes dangerous when retail investors put their life savings into it, or, hypothetically should these products become huge, pension funds sink your life savings into them.
Also fun, Michael Lewis' The Big Short.