April 04, 2014

Ms Tett, in the case of “derivatives”, their biggest danger lies in how delightfully sophisticated they sound!

Sir, Gillian Tett writes about “the mortgage credit derivatives that proved so deadly in that credit bubble”, “The female face of the crisis quits the spotlight” April 4.

One of the problems with understanding our way out of this crisis, are all those who wants us to chase anything they cannot explain, like the sophisticated sounding derivatives. And that stands in the way of attacking the real easy straightforward “vanilla” problems which caused the crisis.

As an example, that which “proved so deadly”, were real securities backed up with different tranches of very real though utterly badly awarded mortgages, something which has nothing to do with derivatives. And the reason these securities, if AAA rated, became so attractive they blinded the markets, was that banks, according to Basel II, could hold these against only 1.6 percent in capital… meaning being able to leverage their equity 62.5 time to 1.

Again what had problem loans to Greece, Spain’s real estate sector, Cyprus’ banks and much else to do with derivatives?

Let me try to explain the issue in my words. In derivatives you always have a winner and a loser, and in this sense, with exception made for the very serious counterparty risk, and which in itself is not a derivative risk but a normal credit risk, what derivatives do, is to redistribute the profit and the losses… in other words they are a wash out.

It is only the losses in the values of real assets which can create the real losses which can cause serious recessions. We should never forget that… while we keep allowing our banks to incur into dangerously large exposures to “ultra-safe” real assets… like infallible sovereigns and the AAAristocracy.