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I was a derivatives trader, and it occurred to me the world would hardly change at all if credit derivatives ceased to exist. Not so nurse practitioners. Is th

• munchbunny 13y ago
  Yes, those innovations are critical, but those central concepts and the legal mechanisms that make them possible have very little to do with what much of Wall Street does, which is inventing financial devices and arbitraging the everloving crap out of them. I think the point of "the world goes on without Wall Street" is that banks and stock markets will still provide speculative capital to expensive ventures whether or not high frequency trading is around, and agriculture will still grow and sell food whether or not hedge funds are buying and selling futures.
• ItendToDisagree 13y ago
  It is debatable if derivatives do more harm than good. Just look at the 2008 financial crisis... From Jaredsohn's link further in the thread: http://en.wikipedia.org/wiki/Derivative_(finance)#Economic_f.. http://en.wikipedia.org/wiki/Derivative_(finance)#Economic_f.... In the context of a 2010 examination of the ICE Trust, an industry self-regulatory body, Gary Gensler, the chairman of the Commodity Futures Trading Commission which regulates most derivatives, was quoted saying that the derivatives marketplace as it functions now "adds up to higher costs to all Americans."
  • tkiley 13y ago
    Best case, what is the societal function of derivatives? As a relatively ignorant layperson, my guess is that derivatives allow productive businesses to hedge against uncontrollable risks. A business with less risks requires less capital buffer, which encourages & allows for more capital investment and profit-taking. In a nutshell, derivatives allow businesses to run and grow on less capital, by reducing the amount of capital-on-hand required to buffer against risk. Is there some other way in which derivatives serve an ostensibly positive function in society? Am I missing something here?
    • ItendToDisagree 13y ago
      As the above commenter stated. In the classical example (and a perfect world) derivatives can act as a sort of "insurance" or guidebook of risk. But we do not live in a perfect world. Greed is a real thing (and maybe one of the reasons Capitalism works so damn well), so it rarely works exactly that way. In the end it is often just a way to treat the little guy as a sucker while insulating the bigger fish. Or at least that is how history has shown it to play out so far.
      • WalterBright 13y ago
        When I was young, I got into a poker game with some local hoods, and they cleaned me out. I knew enough about the odds to know they were cheating, but not enough to know how they were doing it. I resolved not to play poker again until I understood the game much better. Ditto for derivatives. If you don't understand the game, you should invest in something else.
        • judk 13y ago
          My poker experience is actually closely analogous to the reality of AIG meltdown: when I lost, my buddies collected, but when I won, "we were just playing for fun, not real money".
    • cperciva 13y ago
      Is there some other way in which derivatives serve an ostensibly positive function in society? I think the largest benefit is for organizations like pension funds which are required to minimize risk. Being able to hedge against specific types of risk (e.g., via a "longevity swap") allows pension funds to allocate their limited "risk budget" in ways which yield higher returns (thereby allowing them to pay out higher pension values).
      • ItendToDisagree 13y ago
        This is a good point and can be true. As long as the market isn't manipulated this sort of thing can happen. Or even if the manipulation is minimal and there isn't a crash caused by hidden information.
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• pmorici 13y ago
  They had running water and other complex infrastructure in ancient Rome well before derivatives were invented I really doubt we'd be living in a barren wasteland w/o them. There would certainly be an impact if all that stuff went away but it wouldn't be because of it's absence it would be because of the pain of unwinding it all.
  • Tycho 13y ago
    Not to nitpick, but I think they had derivatives before that.
    • wavefunction 13y ago
      Asset derivatives before running water? Do you have a citation?
      • Tycho 13y ago
        Options in ancient Greece http://en.wikipedia.org/wiki/Thales#Business http://en.wikipedia.org/wiki/Thales#Business Forward contracts in Sumer http://www.realmarkits.com/derivatives/3.0history.php http://www.realmarkits.com/derivatives/3.0history.php
    • pmorici 13y ago
      Not in the sense we are talking about them as they relate to financial markets. From what I've read they came about in the 1600's with the rise of the famous tulip bulb bubble. http://husky1.stmarys.ca/~gye/derivativeshistory.pdf http://husky1.stmarys.ca/~gye/derivativeshistory.pdf
• phillmv 13y ago
  It's sorta up for debate. My understanding, which is tiny and very limited, is that you can think of the role of finance operators as "liquidity providers". They're the grease in the wheels of capitalism; by either providing access to capital (via loans, or investment) or by matching buyers with sellers. A classical example is you're a farmer that wants to hedge the risk that your crop will fail due to random weather events or that there will be such a glut in the market that you won't be able to sell your crop profitably. So, you enter a contract to sell your crop at a fixed rate long before harvest comes along. That's a future contract, and it's a kind of derivative. So, derivatives can be really socially useful instruments. They can act like certain kinds of insurance, or allow you to capture different dimensions of value on assets that you already own. However, and here's where the argument comes in, it's not clear that all kinds of derivatives provide socially useful forms of gambling. The prime example here is that of the collateralized debt obligation in which huge portions of the US mortgage market got sunk into. Mortgage backed securities are probably not in of themselves terrible ideas but the way CDOs were structured made it impossible to objectively value the risk behind the instrument. It's just not clear how a dip in the market might affect the value of your CDO tranche. It's actually an np-complete problem - https://freedom-to-tinker.com/blog/appel/intractability-financial-derivatives/ https://freedom-to-tinker.com/blog/appel/intractability-fina... Another example is high frequency trading - where you're a day trader on steroids and have computers exchanging massive quantities of stocks based on fluctuations of fractions of cents. HFT people will argue that they provide more liquidity in the market - it's easier to sell your stocks because HF traders increase the overall volume, etc. However, it's in effect launched an arms race between different trading firms and some people say that they're literally making money by skimming off everyone else who trades stocks. There's a very reasonable argument that we don't want markets to operate faster than human perception. If you have to make a decision about selling something, placing a ground foor and minimum transaction time of say half a second isn't going to harm anyone who needs that liquidity for their business, or anything else that touches the "real economy". To summarize: certain kinds of financial instruments seem to provide no value above and beyond letting well-connected actors to place (potentially ridiculous) bets. Using your money, one way or another - whether it's your farm, the mortgage on your house, or your pension fund. -- If we accept the above as true, we can go further on a limb and ask questions about why is the wealth that passes through financial markets so liberally redistributed to people in the industry? Some people talk about it being a function of volume, but individuals are rarely if ever liable. When do they stop providing a service, and when do they start skimming off the top?
• bonemachine 13y ago
  I'm under the impression that financial innovations throughout history have generally spurred capital investment. Innovations like fractional-reserve lending have made bankers&investors wealthy, but also spurred spending on infrastructure in a way that could be a win-win for society as a whole. The point the author was trying to get at was not that finance geeks don't provide any social utility. Just that in any rational category of needs, the value they provide would have to rank far below the value provide by nurse practitioners (and schoolteachers, police officers, lawyers even... a zillion other working categories, in fact). If today's financial wizards went away, It's not just a question of "if." To all intents and purposes, the financial services sector as we know it today (both in its technical prowess, and in sheer size and scope) did not exist 30 years go. True, we didn't have Facebook or iPads then. But people managed to live healthy lives, raise children, have careers, buy houses, fight wars, etc, just the same. So from one point of view, yes the financial services sector can be seen to grease certain wheels (like IPOs, M&A). But in the larger picture, (in the view of many) it doesn't seem to provide all that much value, in proportion to the resources (and brainpower) devoted to it. It also seems to generate no end of collateral damage (the recent mortgage crisis being just one example).
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• tim333 13y ago
  The statement from the article is basically true. Credit derivatives can be useful to transfer risk from one party to another and may make the financial system slightly more efficient but if they ceased to exist the world would continue pretty much the same. You could argue that the net real effect of derivatives is to transfer money from the real economy to the pockets of bankers and derivative traders and so the overall effect of being rid of them would increase global wealth as some of the former traders would spend time trying to form tech startups instead of trying to get money from your pension fund into their pockets by selling said funds derivative contracts.
• scotty79 13y ago
  Wallstreet has so much diverged from the real world that their financial innovations benefit world as much as invention of new casino game. On the other hand their inventions can hurt economy a lot because they invite to their casino people who apart from gambling use their money for developing economy. They lure them with high and fairly sure profits, but since investing in financial instruments is nothing more than gambling, probable high profits are offset by fairly rare but absolutely devastating crashes that damages players that haven't completely parted with real world economy yet. And that's really harmful.
• D_Alex 13y ago
  >If today's financial wizards went away, would we feel a surprising amount of ripple impact, or would they really just not matter? 1. There would be a substantial impact... for the better. You and I would see the benefit as lower spread between cost of production and price of purchase of goods and services (the spread is where the "financial wizards" take must come from). There is a huge benefit from proper distribution of resources - which used to be the job of financiers and brokers. But now, they work not on "proper distribution", but rather on "distribution which is the most profitable for themselves". 2. And if the "financial wizards" did not go "away", but instead into professions where their intellect could be used for good instead of for evil (e.g.: science), that would be even better.
  • thatthatis 13y ago
    Do you think the same is true of property and casualty insurance? If not, why do you believe insurance mechanisms are damaging in finance?
• speleding 13y ago
  It might be true that credit derivatives add some value to the system, but derivative traders making $8 million a year is not representative of the value they are adding. It is merely caused by the market inefficiencies due to obtaining the required skills and banking licenses and such. And banks are happy to keep it that way, all these extra regulations mostly serve to enshrine their positions.
• hysterix 13y ago
  Wow. Fractional reserve lending is "innovative"? That is hilarious, absurd, and unnerving at the same time. An entity literally creates money out of thin air, and then loans that made up nothing at interest? That is "innovative"? More like criminal. Oh right, and then said entity can't actually allow 10% of all withdraws on itself else it is called a "run" on the banks and they close their doors. What sort of innovation do you see here other than a banking cartel that completely controls the money supply? Comments like yours make me sick because it shows the brainwashing the banking cartel has implemented is complete from the bottom up and unifying; you now have people like you strutting around calling criminal activity innovative. When banks create money it is innovative, when the little guy creates money, it is counterfeiting. Pull your head out of the banking cartels ass for a second, and take a breath of fresh air.
• CreakyParrot 13y ago
  As you can see, it's a hotly-contested issue. But it's a nice, easy way to make the narrative work.