The Real Causes of the Financial Storm
Sunday, September 2, 2007; Page B07
. . . Investment guru Warren Buffett has been warning for years about the dangers of derivatives — the complex financial instruments that undergird modern capital markets. The problem is that derivatives, with their interlocking contracts that are often little understood even by financiers, bind the elements of the global system together while obscuring the weakness of the individual pieces. What happened in August’s panic was partly that nobody in the markets could be sure how bad the subprime fallout would be, because it was obscured by all the swaps and hedge contracts. The French bank BNP Paribas sent the panic into overdrive when it suspended trading in three of its funds because it couldn’t value their losses.
The very mechanism that purports to even out risk has itself become a source of risk. Computer programs are irresistible to investors, who dream of the Valhalla of profit beyond risk.
But it’s not to be. As long as risk-takers gamble against other risk-takers (the basic definition of a free stock exchange), someone will win and someone lose.
Lately, it’s become popular to protect and rescue the losers.