The Role of Derivatives in the Financial Crisis

Weekly Wanderings 6 October 2009

As usual in these weekly musings we present you with interesting items we’ve come across during the week…


From Max Keiser this week at comes an interview with Janet Tavakoli, an expert among experts on structured finance – you know, all those things with funny acronyms like CDO, CDS, SIV, ABMS (A.K.A derivatives) – and author of a fascinating book on the recent and ongoing financial crisis entitled “Dear Mr Buffett”.   The 2 part video interview is below but we also present a summary of the main points below the videos if you’re pressed for time today (or you’re unlucky enough to still be on very slow dial-up internet access!)

  1.  What is a derivative and why have these financial instruments played such a big part in the recent (and still current) crisis? The main reasons are that they are extremely opaque, or lacking in transparency, they enabled the banks to greatly increase their leverage, and they vastly increased the potential for outright fraud.
  2. The Securities and Exchange Commission (SEC) COULD have stopped the resulting Ponzi scheme, but DID NOT.
  3. The major players in this market are banks such as Goldman Sachs, J.P Morgan, Citigroup and Bank of America (these having absorbed the other investment banks). The various mergers and buyouts that have occurred have greatly weakened the entire banking system – the DEBTS ARE STILL THERE.
  4. The Federal Reserve has also taken some of this “toxic waste” onto its own balance sheet.
  5. The problems in the banking sector are still there, just masked. A massive deflationary collapse is occurring – rising loan defaults, falling tax revenues, large increases in government debt and huge amounts of Fed money printing.
  6. Reported GDP growth figures are inaccurate because they have not taken account of this deflation.
  7. This debacle could have been prevented by putting the failing institutions into RECEIVERSHIP, instead of bailing them out.
  8. The problem now is that these massively leveraged debts are mounting, but INCOME to pay interest on the debt and, heaven forbid, even pay back some of the debt, is FALLING.


And for those of you that just can’t get enough of the derivatives or want to hear more of what Janet Tavakoli has to say on the basis of the financial crisis, here is a (long but interesting ) 1 hour interview with her… We won’t hold it against you if you’re not up for it!

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