Derivatives to blame for the debacles at Merrill Lynch and Citigroup?

Derivatives to blame for the credit crunch? Sub-prime mess?

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Blame it on Rio (Risk Ignorant Outlook); blame it on derivatives

The increased usage of derivatives is not the sole reason for the recent spate of debt write-downs by the likes of Merrill Lynch, Citigroup, Countrywide, etc.

Invariably, the unmitigated quest for profit, i.e., greed, combined with a myopic short-term investment focus, mixed in with whirling devirish volatility and the lack of ability to redistribute risk despite the incomprehensible array of hybrid derivatives products, were the "perfect storm" for calamity.

Derivatives have become a bewildering, complex, sometimes nonsensical financial instruments, whose intrinsic value is only on paper, vacuous, as the underlying cash or security has been so sliced and diced and tranched and mezzanined and senior this and equity that to the point that the best, most brilliant minds and quants at MIT, Stanford, Baruch College and the leading IB's on Wall Street could not price or value them with any certainty.

Merton-Scholes would surely be first in line for another Nobel prize in Economics if they could adequately value and model the current litany of hybrid derivatives and securitized financial instruments out there today.

The "Chinese Wall", or should I be more politically correct and say, the "firewalls" that once existed to separate banks, brokers and insurance and assurance entities before the Glass-Steagall Act was effectively repealed in the late 90's, has made for some very questionable bedfellows, passing around mortgage-backed securities like appetizers to each other and leaving the crumbs of the feast to be cleaned up by the wait staff.

Think Fannie Mae.

Not only how they failed in their accounting for derivatives "off-balance sheet" by not marking-to-market, but the tawdry business of "making markets" in mortgage-backed securities, in effect selling the products and buying them back in unrecognizable, grotesque form, and stating them in the journal entries at original value, P&L reflecting inordinate profits.

If only I could do that with my own bank account.

I wouldn't have time to write this article, for I would be in a villa somewhere on a tropical isle.
 
Whilst derivatives have inherent risk, its their use which is what caused the debacles. The securitisation on the MBS's with AAA rating when they were really toilet paper- The fact that the banks sat on the debt they could not sell (usually the riskiest) without hedging themselves properly (It amazes me how abank can package sell debt but keep the riskiest assets they cannot sell and not even hedge the risk with a cds say).

Yes derivatives allowed banks to do what they have,but the perfect storm was cretaed by stupidity, increasingly deregulated financial markets, suspect ratings agency and a fiscal policy held artificially low for too long, throw in the mix the ignitor that was derivatives, and kapow, we a have a financial crisis that happens once every six generations!
 
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