A derivative is like a razor. You can use it to shave yourself and make yourself attractive for your girlfriend. You can slit her throat with it. Or you can use it to commit suicide.
this is originally from the FT, I found it in Nick Hildyard's astonishing paper on the financial crisis.
A (Crumbling) Wall of Money
Financial Bricolage, Derivatives and Power
first published 9th October 2008 | PDF
As world stock markets plunge and even the most neoliberal governments reluctantly move to nationalise banks and mortgages lenders that have collapsed in the wake of the international credit crunch, there is a widespread view that the US and Europe -- so willing in the past to dictate to developing countries on how best to run their economies -- are on the brink of a major slump. Millions are already threatened by job losses or repossession of their homes.
Uncertainty abounds. But the crisis also offers an opportunity for the public to redefine what constitutes the "public interest" and to reassert its claims and interests over how, in future, finance should be managed and in whose interest. Understanding how the current "financial 9/11" came about -- beyond simply blaming "greed and fear" -- may cast light on the deeper structural changes that are needed if history is not to repeat itself.
A starting point for analysis is the largely unregulated "shadow banking system" that financial entrepreneurs have created over the past 30 years, not only to make huge profits for themselves but also to circumvent regulation and to offload risk onto others throughout the financial system. The system relied on the creative use of new financial instruments, particularly derivatives, that allowed financiers to generate easy credit by taking high risk bets while dumping the risks elsewhere.
As a result, they created "a wall of money" that fuelled a boom in corporate mergers and acquisitions across the United States and Europe, concentrating economic power in the process. Easy credit provided huge sums of capital for companies involved in mining, biofuels, private health care, water supply, infrastructure and forestry to expand their activities. When the bets went wrong, however, the pyramid of deals began tumbling down -- and it is the public that will continue to carry the costs for many years to come.
This 117-page 'work in progress' paper (902KB) explores and summarises:
- how the shadow banking system was constructed and why;
- the history of the derivatives, 'hedges' and speculation that underpinned this new finance;
- how derivatives are being used to get around banking, accounting, trading and public finance rules;
- the negative impacts on the ground even before the current crisis;
- recommendations put forward in the past few months on how to fix a broken system; and
- how best to seize the moment to pursue a different system that has a genuine public interest at its centre.