Oct 19 2008

What Have We Done!?

Published by at 9:56 pm under Global Economy,Real Estate,US Economy

“Derivatives are financial weapons of mass destruction carrying dangers that, while now latent, are potentially lethal.” – Warren Buffett (2002)

 

Clearly we are now in the grasp of a financial catastrophe of epic proportion.  Most people sensed the real estate bubble had been going on too long, but few could have predicted the storm we are now experiencing would reach nearly every developed nation in the world.  The fallout is certainly global and it is high time to focus on solutions, but in the U.S., thanks to the pending presidential election, it has become quite the political finger pointing exercise.  The Republicans are blaming initiatives supported by former President Clinton and other Democrates which made it easier for people of lesser means to obtain mortgage loans.  The Democrats are furiously pointing towards the efforts of Republican Phil Graham who pushed through a law that exempted financial derivatives from federal regulation.  There should be little argument that it became far too easy to qualify for mortgage loans, but without credit derivatives we would never have reached the global meltdown that will ultimately reshape our financial future.

 

So who is really to blame?  A whole lot of highly intelligent and clever financial wizards…and everyone else in a position to challenge what they came up with.  In other words, there is plenty of blame to go around.  The focal point, however, should probably be directed at former Fed Chief Alan Greenspan.  He was central in first creating the “easy credit” environment and then allowing the credit derivative to become such a popular form of “insurance” against borrowers defaulting on their debts.

 

I wrote the following in an essay on financial derivatives for a masters course I was taking in February 2006: “Ultimately there is a single major risk to be concerned about when dealing with financial derivatives.  There is the potential to lose a great deal of money over a short period of time on a “wrong” position.  As in the case of Barings, if adequate reserves are not available, this could result in bankruptcy.  Derivatives-related losses can typically be traced to an overly speculative investment strategy, a misunderstanding of how derivatives reallocate risk, an ineffective risk-management audit function and an absence of systems that simulate adverse market movements and help develop contingency solutions.”  I would argue that our current predicament confirms that relaxed mortgage loan requirements combined with the widespread use of credit derivatives was a poison pill the size of Manhatten.  Now we must hope the apparent antidote (which is closer to the size of Great Britain) works in a big fat hurry.

2 responses so far

2 Responses to “What Have We Done!?”

  1. […] Original post by http://www.bbfin.com […]

  2. Federal Mortgage Commissionon 22 Oct 2008 at 2:30 am

    Federal Mortgage Commission…

    It is important that you unmask the leading authorities….

Trackback URI |