Derivatives: So Much Like Financial Alchemy

You have to admit, he's got a point...

But seriously the problem with derivatives is that 90% of the people who are involved them are doing so based on improper assumptions, and don't fully understand the instruments they're dealing with.

Just think about:  lot of mortgage securities were marketed, sold, etc, based on the idea that "property values always go up",  "people always pay their mortgages" and the use of mortgage related securities and derivatives dilutes the risk to the point where no one really suffers. Now these ideas sound ludicrous in light of the events of the past 12 months, but they should sound equally ludicrous to anyone who remembers the S & L crisis and the fact that it took most of the 90s for many real estate markets to recoup their losses from the late 80s/early 90s.

I.e.  in many cases derivatives amount to financial alchemy, and at the end of the day alchemy is NOT science.

Comments

[investor88:]

Nice summary of the wrong assumptions [property always go up, mortgages get repaid, derivatives dilutes risk to the point of being harmless]. It took a decade for the S&L crisis to be papered over, it may take as much time for the present crisis to be totally over and forgotten.

2008 Oct 14 07:38 PM