Derivative Dangers

This is part 3 or an ongoing series on the financial 3Ds - Debt Derivatives and Deceit.

What are derivatives?

Derivatives are financial instruments that derive their value from another financial instrument. Exchange traded options are an example.  You may have heard of speculators trading puts and calls on specific stocks, indexes and commodities. The narrowest definition of derivative also includes an instrument with an expiration date. They have 2 purposes – price insurance and speculation.

Less obvious examples are financial instruments that track indexes like the Spider (SPDR) that tracks the price of the Standard and Poor’s 500 Index.  ETFs (Exchange Traded Funds) are technically derivatives even though the are not generally considered as derivatives. They are considered less risky because there is not a decaying time value associated with them.

Most of the derivatives in existence are Over-The-Counter (OTC). This means there is no established exchange for these instruments that creates a liquid market for them. Only institutions owned by the 2% can own them – primarily banks and investment companies. They tend to be so complex that only financial “rocket scientists” can understand them.  They are so complex that no single “financial rocket scientist” really understands more than a few of them at a time.

 Why care about derivatives?

The Bank for International Settlements says that (as of November 2013), there are $561 trillion of over-the-counter interest-rate derivatives (such as swaps, forward rate agreements and options).  The banks are generally on one side of these derivatives of debt. This  new time bomb is almost 450 times the size of the subprime mortgage derivative market that almost overwhelmed the global financial system in 2008. For reference, this is almost 36 times U.S. GDP.

The next financial crisis is baked into the system. For the first half of 2013, the Federal Reserve’s Quantitative Easing was creating as much federal debt every month as was in existence at the height of WWII. Since then, it has  “tapered” to $2,500,000,000 a day.

 Reasons I’m telling you about them:

  • So you know that discovering and creating alternatives is vital. There are so many cross-currents of change out there that we can’t reliably forecast what is going to happen.  All we can do is be prepared.
  • Whatever financial craziness happens, derivatives will amplify the affect. Murphy’s Law says that you will be on the bad side of that affect
  • This is scary stuff that causes most people to freeze like a deer in the headlights. You change agents must have experience and empathy to help others understand that the alternatives we are helping create CAN KEEP THEM ALIVE AND FUNCTIONING!
  • Besides, it is exciting to build something new!  Here is a quote from Alice Iida’s “The Red Pill Book”

 Designing a system that leads to sustainable prosperity is an epic challenge… [It] must create greater security, open government, and open business practices. Changing the world is a huge growth opportunity…

We need as many people as possible who are thinking for themselves and sharing what they know… [creating] the pieces of the puzzle that come together. We need individual action that will influence others. Only passion changes the world… we should aspire to doing the right things (not everything).

Don’t be a part of the problem, phase these toxins out of your financial life!


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