Derivatives: Financial Weapons of Mass Destruction
The reoccurring topic in the midst of the economic crisis effecting countries around the world is derivatives trading. It is a risk financial institutions take that has no benefit to customers, and can cause an outcome that will throw an economy into financial disorder.
The activity in derivatives trading among federally insured banks is an ongoing problem. Derivatives are a credit vehicle created by JP Morgan years ago as a way for banks to diffuse their risks and heighten leverage in the global financial system. It was a success. However, the trading eventually backfired and contributed to the 2008 financial crisis in the US. Warren Buffett refers to them as “time bombs” and “financial weapons of mass destruction,” but even he still uses them. The current crisis in Greece is partly due to these dangerous “weapons”. So why are banks and other companies participating in such risky behavior? Is the outcome really worth the risk? It is one thing when a strategy is unsuccessful and money is lost, but a strategy that has been known to bring down an entire economy should it not pan out—raises many concerns.
What’s the Big Idea?
Financial institutions and other companies should not be able to gamble at will. There needs to be transparency and agencies established to regulate the activities of companies that dabble in derivatives trading. The Volcker Rule was added to the section of Dodd-Frank Wall Street Reform and Consumer Act to restrict US banks from participating in activity not in the best interest of their customers; however exceptions have been made. Although new provisions to the rule have been addressed, a decision will not be made until the end of the year.