Derivatives derivatives derivatives soooo many

Was going through Zerohedge and find some interesting facts the (TBTF) Too Big To Fail get Too Bigger To Fail. The top 5 banks of the world holds 97% approx $221 trillion derivative outstanding.

$220 trillion is more than enough for the world to collapse in a daisy chained failure of bilateral netting (which not even all the central banks in the world can offset).

Time and again history has repeated itself unregulated derivatives are prone to catastrophic failure. And yet, nearly four years after the crash, and nearly two years since the passage of the Dodd-Frank law, the multitrillion-dollars derivatives market is still dominated by a handful of big banks, and regulation is a slow work in progress. Unregulated derivatives are still an economic threat. That’s because derivatives have become deeply embedded in the global economy. ( an article from Ny times quoted)

What is known is that the banks make billions of dollars a year on derivatives deals — lush profits that are surely higher than they would be if the market were transparent and competitive. Overcharging means that bankers are enriched with money that companies could otherwise invest in their businesses and that consumers could otherwise keep in their pockets.

Having traded derivatives professionally,for a very short-term . I’ll say this…they are a good idea gone terribly awry. The first derivatives. were invented” by the World bank and IBM. These two institutions exchanged floating rate debt for the other’s fixed rate debt. This swap fit the financial needs of each very well.

6 thoughts on “Derivatives derivatives derivatives soooo many

  1. I agree…derivatives are a good idea gone askew. They truly can be very helpful in hedging various types of risk, but it seems inevitable that popular financial products of any kind get exploited by institutions who have large resources and networks. Unfortunately the global financial system has evolved into something unmanageable with too much capital concentrated at too few financial entities.

    Unless regulation catches up, as you point out, and the financial system goes through some serious structural reforms then I am afraid I have to agree that history is doomed to repeat itself.

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    1. True Ryan ..indeed its the time for regulators to closely monitor the action in derivatives.. because the market for Latin america , Emerging economies in Asia is yet to be explored 🙂

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    2. I beg to differ, its not like derivatives are “good idea gone askew”, its a bad idea which will prove time and again as a bad idea. I think the very foundation of derivatives (Efficient Market Hypothesis by Eugene Fama) is pretty flawed. Because the crowd in general are neither efficient nor rationale, when market hits Black Swan events.

      Market history since the birth of derivatives is littered with crashes & accelerated panic attacks…its just a case of passing live grenade from one hand to another….hoping you are not the one to hold when it explodes.

      Any given financial model (Say Black Scholes) is designed to understand the market, but when a critical mass of traders start following the model (again, Black Scholes) to predict the market….It becomes difficult to understand who is mimicking whom. A case of a good liar believing his own lies.

      On the long term, its wise to bet against every gambler in the room (including the dealer)

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      1. Deepak much appreciate your remarks , Derivatives are in existence since 16th century and the models came later , Its only the Crisis (black swan events) reveal that where was the model flawed , be it LTCM, Lehman , P&G. . Its the tabloid culture which is running in the society and you have to be a part of that society with once rational views 🙂

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  2. When you say 16th century, i believe you are referring to Dojima rice derivatives in Japan….just so you know the Arabs & Indians had a futures derivative for Gems, spice & herbs trading, much before that…. 😉

    I am not against derivatives in general, what bothers me is Institutions seeing derivatives as an instrument of insurance against major shocks, that is wrong….Derivatives don’t work just when you need it to work the most….But hey, it works for traders/brokers who make the margins trading them…

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    1. That’s the problem bro , It’s very simple where I tried to figure out the hierarchy of the trading floor. There are Sales people – they lie to clients. Traders lie to sales and to risk managers. Risk managers ? they lie to people who run the place – a small correction they think they run the place. The people who run the place lie to shareholders and regulators ..

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