Derivatives Risk A Brief Rant
Michael S. Rozeff
by Michael S. Rozeff: Another
Neo-Greenbacker Central Banking Scheme
Today I read
a very technical article on credit derivatives as used by banks
(and other institutions), and in the end I came away thinking "this
is madness." There are so many hairy problems involved here
in attempting to price these things and no one knows the answers.
I think answers are unobtainable. The assumptions being made about
measuring risks are untenable. In an "Austrian" world,
no one can predict them and past distributions do not suffice. Banks
doing large amounts of trading in derivatives do not know what their
risks are. However, astoundingly, huge sums of money are recorded
as gains and losses on accounting statements based on estimates
of risk parameters that no one actually is sure of. I kept thinking
that these banks are doing all this trading while having their deposits
insured and the FED as a backup. This is a huge moral hazard problem.
Mention was also made of the re-hypothecation issue that can set
off unknown chain reactions of failures. The MF Global collapse
is the canary in the mine. If the dollar had stayed anchored to
gold, we would not have had the explosion in derivatives. They grew
at first mainly as instruments to deal with the increased risks
in interest rate and currency volatility. But now almost any company
plays with these things. I have a hard time believing that it's
efficient for companies routinely to be using these as supposed
hedges. It's hard to find good reasons why such activities add value
for stockholders. The financial companies and banks have used them
off-balance sheet and to create excessive leverage, while regulators
allowed it. The whiz kids at these banks could wave mathematical
models and jargon at them endlessly, as they are doing again at
Basel where there is yet another vain attempt to control the moral
hazard in banks. The last time around, sovereign debts were thought
to be riskless and always excellent collateral. If ever a system
cried out for a complete reset, it is the monetary system.
S. Rozeff [send him mail]
is a retired Professor of Finance living in East Amherst, New York.
He is the author of the free e-book Essays
on American Empire: Liberty vs. Domination and the free e-book
The U.S. Constitution
and Money: Corruption and Decline.
© 2011 by LewRockwell.com. Permission to reprint in whole or in
part is gladly granted, provided full credit is given.
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