Why the derivative explosion?

[gwynedd1]

Re: Why the derivative explosion?

I just had someone try and sell me an indexed annuity because there is "no risk". I was curious and let him do the presentation. There was no down side loss and the only down side was it was capped at 12%. Yep, there is no risk in nominal terms. What happens if the rest of the world does a bank run on the US and I am capped at 12%? Yeah, I don't think so. Then of course if the insurance company goes bust....there is that too.

[jiimbergin]

Re: Why the derivative explosion?

I just had someone try and sell me an indexed annuity because there is "no risk". I was curious and let him do the presentation. There was no down side loss and the only down side was it was capped at 12%. Yep, there is no risk in nominal terms. What happens if the rest of the world does a bank run on the US and I am capped at 12%? Yeah, I don't think so. Then of course if the insurance company goes bust....there is that too.

the big down side risk is usually the surrender costs during the first 7 or 8 years. Much of the profit actually is in the early surrenders in addition to the spread, however that is defined.

[jiimbergin]

Re: Why the derivative explosion?

Then of course if the insurance company goes bust....there is that too.

In theory, at least, you are protected from the company going bust by laws that allow the insurance commissioner to take over any problem company and make up any policy owner losses from other companies licensed in that state. However, that does not help if many companies go bankrupt.

[charliebrown]

Re: Why the derivative explosion?

I have heard from unreliable sources that a lot of the CDS have to do with interest rate swaps?
With ultra low rates bond holders are looking for protection from rising rates. I have also heard that
(tin foil hat on) that the big U.S. banks are buying long treasuries, and using CDS interest rate swaps to
swap away the interest rate risk. (tin foil hat off) I guess they can still make money holding the bond and buying
the swap, which allows them to buy many more treasuries than they would otherwise hold. The treasury and regulatory
bodies knowing this is the only way they can run 10% deficits at low interest rates look the other way. The only thing is
who has deep enough pockets to back the CDS if interest rates spike? China? Champion of Europe?

[c1ue]

Re: Why the derivative explosion?

You may be giving a bit too much credit to the CEOs, who more often rose to the top because of their mastery of internal politics and not their quantitative or risk management skills. (Exhibit 1: Jon Corzine.)

Some of the CEOs grew up in the business when it was much simpler, before the quants took over with their exotic products. Frankly, I wouldn't be surprised if some of the CEOs didn't have the intellectual horsepower to understand the derivatives business and the resulting risks (if they were even inclined to try to understand the business in the first place, which, as you point out, has some ugly implications.)

The CEOs might not personally understand, but they have staff, do they not?

Are you seriously trying to say that no one in the entire comptroller side of these companies had any idea what was going on?

From my view, the CEOs of the bankster companies saw big profits and big bonuses - not only their own - and didn't ask any steenkin' questions, even if they didn't actually assist in the control fraud within their own company.

[mmr]

Re: Why the derivative explosion?

The CEOs might not personally understand, but they have staff, do they not?

Are you seriously trying to say that no one in the entire comptroller side of these companies had any idea what was going on?

From my view, the CEOs of the bankster companies saw big profits and big bonuses - not only their own - and didn't ask any steenkin' questions, even if they didn't actually assist in the control fraud within their own company.

Not disagreeing with your points regarding the CEOs. However, some of the CEOs might not have had the intellectual horsepower to understand the risks that their companies were taking even if they had tried.

Rising asset prices combined with massive amounts of cheap debt covered up for a great deal of incompetence and negligence, in addition to outright fraud.