(MODS - please transfer this to the "Economics" section after a seasoning perion here)

"A popular candidate for the next big problem is the 'over-the-counter' (OTC) derivatives books of the banks. Many articles have been written about how huge these exposures are, and how losses in this area may trigger an even larger crisis in the global financial system. A meltdown could happen, but if it did, it might simply occur because fear spins out of control, and the desire to stop doing bad business prevents the banks from doing any business at all. A frozen financial sector would create huge problems for the US and for the global economy, and may even trigger a depression. But it need not happen. As Franklin Delano Roosevelt once put it in the depths of the 1930's depression, "The only thing we have to fear is fear itself." Panic can be avoided, provided the risks are better understood and better managed.

Risk on OTC derivatives is not easy to extinguish, and gets over-counted

• The OTC derivatives market is vulnerable and is seen as the likely vector through which credit problems could spread rapid-fire, right through the whole banking system. The real risks in these OTC trades are not well-understood in the articles in the popular press. Frankly, the size of the risks are often miscounted and may be overstated and exaggerated by the mainstream press. For example, I have seen reports which talk about bank derivative exposures approaching $50 trillion.

Understanding the true risks requires diving into a level of detail which is deeper than most journalists, or the average readers of such articles, find comfortable. I want to ask readers of this article to bear with me, as we make a brief journey into complexity."

/more explanation of this little understood area, in an article in MoneyWeek:
a-better-understanding-of-otc-derivatives-is-vital-to-us-all
/see: http://www.moneyweek.com/file/49989/a-bett...-to-us-all.html

Can't we just delete this and continue to use

http://www.housepricecrash.co.uk/forum/ind...showtopic=79344

where we have debated this in much greater depth than the article?

How presumptuous! I'm sure that thread will be of interest to some but not all of us have the time to trawl through 23 pages.

Surely it only takes a counterparty failure and the whole lot goes down like a sack of sh1t.

Satyajit Das is laughing. It appears I have said something very funny, but I have no idea what it was. My only clue is that the laugh sounds somewhat pitying.

One of the world's leading experts on credit derivatives, Das is the author of a 4,200-page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years, he seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch -- and I expected him to defend and explain the practice.

I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the "third inning." This was pretty amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?"

Still too optimistic. Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy.

Das is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions.

The cause: Massive levels of debt underlying the world economy system are about to unwind in a profound and persistent way.

There is a perennial debate about financial WMD (weapons of mass destruction) – derivatives.

The most interesting debate was between two giants of American capitalism – Warren Buffet and Alan Greenspan.

In 2003, Buffet took aim at derivatives calling them “financial weapons of mass destruction” (“What Worries Warren” (3 March 2003) Fortune). He was joined in this crusade by a few notable figures. Their complaint seemed to be that derivative contracts had hidden losses that would eventually emerge. This would affect the banks and insurance companies who traded in these instruments. They were concerned that derivatives allowed companies and investors to gamble with other people’s money. I have always naively assumed that gambling with other people’s money was part and parcel of capitalism. The catchy line with its characteristic homely wisdom and the fact that it was Buffet ensured immediate airplay.

The major defender was Alan Greenspan, Chairman of the Federal Reserve Bank of New York, effectively America’s central bank. Its responsibilities include ensuring the integrity of the financial system and stability of banks. The head of the central bank’s role as cheerleader for the derivatives lobby was curious.

Greenspan had succeeded Paul Volcker in the late 1980’s. Volcker had embarked on an unpopular strategy of high interest rates that had ultimately proved successful in beating inflation. There had been collateral damage. The entire US Savings & Loan Industry had ended up as road kill. But the high interest rates opened up la Belle Époque - an era of low inflation, low interest rates and rising stock prices. Chairman Greenspan found himself in command of the ship just as it sailed into calmer waters. Woody Allen observed that 80% of success in life is just showing up at the right time. The Maestro, Greenspan’s nickname, had immaculate timing.

The tennis playing, jazz saxophone loving Greenspan has presided over an unparalleled period of prosperity, the bond market collapse of 1994 and several asset price bubbles and collapses. Greenspan is famous for two other things - prolix sentence construction and an unfettered belief in new technology.

Greenspan’s regular congressional testimony attracted financial analysts, journalists and linguists in equal numbers. An industry in interpreting Greenspan’s prognostications has developed. Without a hint of self-parody, Greenspan himself provided guidance to interpreting his pronouncements. “I know you believe you understand what you think I said, but I am not sure you realize that what you heard is not what I meant,” the Maestro once offered as explanation. He further clarified his position with unusual directness. “If I have made myself clear then you have misunderstood me.” (David James “Wot’s all this then, Alan?” (10-16 July 2003) BRW)

Now, Greenspan turned his considerable elocutionary powers to the defense of derivatives. During the height of the Internet boom, he held forth lyrically and at length on the impact of technology on productivity. Greenspan’s infatuation with derivatives appeared no less intense.

“By far the most significant event of finance during the past decade has been the extraordinary development and expansion of financial derivatives….. As we approach the twenty-first century, both banks and non-banks will continually reassess whether their own risk management practices have kept pace with their own evolving activities and with changes in financial market dynamics and readjust accordingly. Should they succeed I am quite confident that market participants will continue to increase their reliance on derivatives to unbundle risks and thereby enhance the process of wealth creation.” Remarks at the Futures Industry Association, Boca Raton, Florida (19 March 1999).Thus spake Greenspan.

Surely it only takes a counterparty failure and the whole lot goes down like a sack of sh1t.

My HPC Post

So your saying Das doesn't understand the Derivatives market? I can accept you have to take with caution anything anyone says as they will be promoting their own agenda, but what are the 2 extremes? Is Das on the crash extreme side whereas your view is the least extreme outcome side? Which may put the truth somewhere in the middle.

http://articles.moneycentral.msn.com/Inves...ket.aspx?page=1



http://www.wilmott.com/blogs/satyajitdas/i...are-Derivatives