Remember those 74 books I mentioned to you a couple of columns back? One of them actually has the “D” word in its subtitle. The author is Satyajit Das. The full title is “Traders, Guns, and Money: Knowns And Unknowns In The Dazzling World Of Derivatives”.
Now I want you to go into Google and type in “Open Gamma Quantitative Research: The Pricing And Risk Management of Credit Default Swaps With A Focus On The ISDA Model”. ISDA, by the way, stands for International Swaps and Derivatives Association. So there is a bit of organization to the chaos! The late, great Ed McMahon would have shouted, “Everything you ever wanted to know about a credit default swap………. can be found in this on-line booklet”.. The second to last page offers an index of headings of other types of private derivatives and how they work.
Here’s a second piece, sitting on-line as a power point presentation: “A Practical Guide to Credit Derivatives” (Oxford Law and Finance Senior Practitioner Lecture. Antonin Besse 7 November 2012). Put on your math hats and go in and see for yourselves how complicated those contracts can be. Then change your Google search to interest rate swaps, currency swaps, and commodity based derivatives. You will find similar, lengthy, mathematically charged explanations for those crapshoots as well.
Can you now see why most CEOs and CFOs would not understand how they work? Who was supposed to inform us about their existence? The media? So we have exponentially leveraged speculations strangling the globe’s money supply, and few people really understand how they work…….and even fewer “experts” understood the ramifications of their leverage and illiquidity when the system went haywire after the Lehman bankruptcy.
I do not want you to believe that the entire marketplace is too difficult to engage. Recent innovations have helped people participate in the global commodities markets without risking any more money than was originally spent. ETFs are as easy as buying and selling a stock and have taken the place of the futures markets for many investors/speculators…..especially since most of our investment firms now prohibit their brokers/advisors from futures trading. The managed futures fund is as close as you can get these days.
This ongoing institutional gambling casino, aka the private derivatives markets, carries more exponential risk than any other medium. No other entity has ever wreaked this much financial havoc on society. Look at TARP. Look at the 16 trillion dollar “secret” bailout. I imagine we will need another GAO report to find out what the U.S.A., aka the lender of last resort, lent/gave to Europe in 2011-12 to alleviate its crisis.