Lisa Simpson
Mar 16,2010
In: Finance

The Betting Game of Derivatives

The derivatives are taken to be the prime culprit behind the financial crisis.

The derivatives are taken to be the prime culprit behind the financial crisis. Pundits consider it to be undercover deals. The attempt by the government is to rein these in and make their operations more pubic so as to avoid a repeat of the recent financial crisis.

Professor Lynn Stout has been focusing on law. He had giving warning about the impending doom but none had heeded. Referring to derivatives he said, “They are nothing more than a bet on what’s going to happen. You can think of derivatives dealers as bookies. They make a tidy profit by collecting bets. They’re good at it.”

Firms in Wall Street firms sell contracts in derivatives and they also trade in it themselves. According to the estimates of Bloomberg Business News it is forecast that trading in derivatives will create $35 billion revenue for Wall Street in 2010.

Derivatives are increasingly becoming speculating tools. It involves two types of risks – one can lose the bet on the underlying asset and one can lose on the money if the opposite party fails to pay up at the termination of the contract.
Jamie Dimon of JPMorgan Chase (CEO) said, “There’s absolutely a place in a free world for bilateral contracts between consenting adults. Corporations with businesses around the world, airlines say they need to hedge their risk. Regulators need to make sure it’s under control.”

During the fall of 2009 the derivatives market became unmanageable. When the sub-prime mortgages began to tumble the investors lost their faith in AIG. The latter had issued a derivative that was termed credit-default-swap. It translated to an insurance policy against losses from sub-prime mortgages. This triggered off the panic. In 2000 the Congress had given its vote to exempt the OTC (over-the-counter) derivative market from regulatory monitoring. None knew whether the counter parties were in health or not – strong enough to honour their commitments.
The Obama government together with the Congress is keen to tighten the regulations on the OTC derivate markets. There are differences in the proposals but the ultimate goal is the same – pushing some of the derivative deals into the clearing houses where they can be controlled. The final goal is to nudge these deals towards the public.

It is expected that those trading in derivatives would have to keep more reserve or security guard against losses and operate more meticulously in the matter or record keeping.