Monday, March 1, 2010

DDT: Derivative Disaster Of Tomorrow

It is Monday, and while I don't want to rain on anyone's parade, I am back to talking about the mess the future for financial regulation in the United States is in.

Very few people understand what a derivative is. In fact, if the population of the United States had as much understanding of what a derivative is, as they do to what cancer is, we would have meaningful regulation from Congress coming down the pike to guard us against another financial disaster. The unregulated derivative business, the part of AIG's business that required the Federal Government to bail it out of certain bankruptcy, and bringing about a world wide financial panic, is what I am talking about. Unfortunately, after all these months since the bailout by the Federal Government, we, as a nation, are no further along to building a better regulatory environment for derivatives. In the next financial panic, there might not be enough cash, credit or confidence to backstop the crisis.

So, while Congress plays with all our lives, with their collective heads in the sand, I am telling everyone, as James Baldwin once said, it may be "the fire next time."

Stay tuned.


winslow said...

For being an "educated" country, we're pretty backward

Julie Schuler said...

I don't know what derivatives are. I heard that 95% of the world's wealth is in derivatives. I thought it was sort of like a lot of IOUs put into one box and then everyone pretends that box is full of sapphires and rubies.

Kathryn Brimblecombe-Fox said...

Perpetual playing pretend paints a fantasy which after awhile people start to 'see' as reality!

LceeL said...

Did AIG hold derivatives? Or did they hold the credit default swaps - which were bets against the derivatives?

moneythoughts said...

AIG sold credit default swaps to the investment bankers, like Goldman and Morgan Stanley, that underwrote the mortgage-backed and other structured debt obligations CMOs. These then were cut up and re-packaged. The re-packaged pieces were also derivatives. The credit default swaps were basically insurance policies sold to the Goldmans and the Morgan Stanleys that would pay them if the bonds went under - defaulted. Unfortunately, there were no reserved required by insurance regulators because the credit default swap market was totally unregulated. When the investment bankers asked AIG to put up more collateral, they had none, nor cash to put up. Then the Federal Gov't came in and bailed them out. Goldman got about $12.9 Billion from AIG for the credit default swaps they bought. Isn't finance fun?