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can someone explian derivatives for me?


can someone explian derivatives for me?

Old 02-27-2009, 10:40 AM
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Question can someone explian derivatives for me?

I read that derivative(sp) contracts may have over a 1/4 quadrillion dollar value and the problem is not as much the amount of the bad mortgages but that they were used somehow to make the economy more "liquid" than the central banking folks intended. If just 10% go bad we take a 25 trillion dollar hit. what is the real scoop?
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Old 02-27-2009, 10:59 AM
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A derivative is a fiscal instrument that derives its value from another fiscal instrument, not from tangible goods/property or cash.
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Old 02-27-2009, 12:11 PM
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Credit Default swaps (the derivs you are probably referring to) are a fancy name for INSURANCE on the value of a security. You can buy the protection in case of default or you write the policy (contract) to take in the premium. Unlike traditional insurance it is not regulated and therefore NOT reserved against in case of a claim or LOSS. Therefore many of the contracts (policies) that are out there, the counterparty has no ability to pay. AIG Financial Products wrote alot of these contracts and they did not adequately reserve against the premiums they were taking. This is a Rather oversimplified and crude explanation but Google more on AIG Financial Products and you will get a better understanding.
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Old 02-28-2009, 02:44 PM
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Default The Oracle from 5 years ago


Read it and weep.
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Old 02-28-2009, 03:48 PM
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A friend sent me this narrative account of what went on. I would like to kick someone.

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Old 03-01-2009, 05:48 AM
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Interesting article. I only hope that people won't view it as exonerating the borrowers, mtg brokers, govt, et al, who all contributed to the situation we are currently facing.
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Old 03-01-2009, 06:42 AM
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There is nothing wrong with derivatives, just like there is nothing wrong with steak or candy - but if you consume too much of them, with no supervision, or they go to the wrong people, or the raw materials used to make them are poisonous, then they can be fatal.

The issues with the mortgage situation were the following:

1. They changed the rules by which mortgages were made without changing the rules by which they were handled post-closing. Giving mortgages to those with no equity or verifiable income was just plain stupid.

2. The perception of risk from those that bought and sold them was based on history

3. Rating agencies continued to stamp them investment grade despite the fact that by any objective analysis they were junk

4. Those that were writing credit default swaps did not do proper risk analysis on their positions. Insurers by actuarial rules, and by definition, should never allow themselves to reach a position where their exposure to claims in any one area is large enough to obliterate their equity. They are supposed to be in the business of spreading risk, not gambling.

5. The agencies that regulate the banks, rating agencies, and insurance companies failed to do their jobs. Part of it was the fact that the instruments were new (and they are generally staffed by government bureaucrats whose talents are limited to doing whatever they can to keep their cushy government teat job and are incapable of thinking outside the box. And I have no doubts based on the revelations in the Madoff case from Markopolous that they were paid or otherwise induced to look the other way.

6. Boards of directors at the financial institutions are stacked and are ineffective at reining in management, especially when profits are soaring - the whole system of corporate governance is broken

This was a failure in public policy, and a failure of the government to execute their proper oversight role. Until we evolve as a people, greed and self-interest will always be a part of commerce. You can't expect them to operate on the honor system, but when the government is incompetent, corrupt, and self-serving, it is a recipe for disaster.

This begs the question "who is policing the policemen", and the answer is in the mirror. I won't risk sending this thread to the bilge by going down that line of discussion, but suffice it to say that is the system that is really broken - not the financial system.
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