The Case for Derivatives

Shiller is right. Derivatives are not bad but how they are used in US was bad. US as an economy was probably hedging risks within itself which means all financial firms in US were seem to hedge their risks by transferring it to other firms in US and so it collapsed. What US firms need to understand (and they might do as well) is that when they are buying services and products from outside US with less exports to balance the outlow of money then over a period of time there will be systemic risks building due to this outgoing money creating enough vacuum that might show up as losses in jobs, collapses of banks, etc. It looks like bad real estate debts created problems or derivatives created problem but it is actually excess outflow of money from US to other worlds. Now when you are buying services or products from out of US then you are actually paying for their growth and you need to ensure that what you pay out should be more as an investment in their growth rather than payment for service and products. One way to do this is to assume that your effective cost per hour is 5% more and that 5% is invested in derivatives of the country that you are paying money to. For eg, if you pay 20$ / hour for a chinese or Indian software programmer then assume that you are actually paying 21$s (5% more) and invest 1$ in the derivatives of Indian and Chinese economies (stocks of the companies you are paying to) in 6 monthy contracts and as they are grow from your money.... this 5% investment in derivatives would be equivalent to 100% of actual and hence you will get your 20$s back soon by investmenting in this way.

Summary is that US firms need to become investors in foreign economies by the route of derivatives and thus keep a balance. In a way, US would need to become investor in emerging markets rather than mere payer for services in order to sustain in longer term. US would be investing in the growth of the world and without compromising their own financial health because you would have stake in the growth of foreign country.

Above is not possible without derivatives.

Shiller could be right ... could be wrong in theory, what I do know is that the that homebuilders' could utilize some type of efficient hedge instrument to back homebuyers' investment in new homes. We have looked at the CME products in depth ... their close, but no reliable liquidity. Consider being able to purchase a new energy efficient home backed with extended third party warranty insurance and purchase price protection for 3 - 5 years ... it's all there today except the purchase price protection. How do we get from today to tomorrow with efficient price protection.

Typical thinking from someone at the Bush alma mater. Don't do real work. Don't do any real analysis. Don't invest in real capital assets or means of production. Speculate and then speculate on the speculators. At least there will be more speculators to make a market more liquid. Voila, my Emperor, everyone is impressed with your new clothes.

Karabell, are you related to Shiller or something? You are the only journalist promoting this guy. And just because you get to print it in Newsweek, that does not legitimize the Shiller/Karabell argument for more derivatives (see: emperor???s new clothes).

To find more irony wrapped in Shiller???s analogy of the Titanic please READ: ???The Titanic???s Last Secret???, Jeneen Interlandi, NEWSWEEK October 13, 2008. You will see that the Titanic failed from fundamental structural flaws before it ever set to sea???much like Shiller???s derivatives. And the underlying reason: profit motive, i.e. greed of a CEO.

If Main Street demands it, Wall Street will invent it. Remember that line about necessity and mothers?

Shiller is right - the tools are not the problem, it's HOW they are used. The only danger is when the tool itself gets too complicated to use.

"We've had a major glitch in derivatives and securitization," says Shiller. "The Titanic sank almost a century ago, but we didn't stop sailing across the Atlantic."
Either Shiller or Karabell is way way off base here. We continued to sail across the Atlantic after the Titanic because we knew exactly what had happened (iceberg) and what to do to avoid it (be careful if there are likely to be icebergs around, and never assume your state-of-the-art vessel is unsinkable), Duh!

If the Titanic had suddenly begin to spring multiple leaks and no one knew why, then (assuming that word of this reached shore and was believed) transatlantic shipping would have shrunk. If the same thing happened to a few other ships, shipping would have virtually stopped until the problem was understood and a solution or workaround was found.
To improve the analogy, suppose that some of the passengers on the Titanic were leak experts associated with various shipyards, each with its own patented method of fixing leaks, and that after examining the leaks, each such passenger came up with an explanation of them that would use his company's products and facilities to fix them. The captain then has to choose which shipyard to head for, and of course must choose before the ship sinks.
Using this analogy, it seems to me that Karabell and Shiller work for some shipyard or other, when what the captain needs is an expert without ties to any particular shipyard.

Rule of thumb -- if someone uses an analogy that works only until you start thinking about it, he is either sloppy or pimping for something.

Karabell would have us believe that derivaties are still a good deal, but he really doesn't explain what they are or how they work, other than to say they're "a financial contract between a buyer and a seller that derive value from an underlying asset. . . ." and they're like insurance. No thanks. I doubt very much that we'll ever see much investing in them again.

Karabell would have us believe that derivatives are still a good deal, yet he doesn't really explain what they are or how they work, other than to say they're "financial contracts between a buyer and a seller that derive value from an underlying asset. . . ." and they're like insurance. No thank you. I doubt very much that we're going to see much investing in them again.

There is no reason why real estate should be seen as an appreciating asset. Real estate is more like a commodity. Homes are used not invested in. There is almost unlimited supply and very predictable demand. The illusion that real estate is in demand comes from cultural trends. When cities become popular or crowded, some neighborhoods become interesting, trendy, chic, or whatever. But the same house can be built in Beverly Hills or Houston, Texas and have vastly different prices. Many companies have recognized this and controlled costs for employees by locating in more affordable states and cities. Derivatives could be designed for Dutch Bulbs or Otter hides, but why? The most amazing thing is that Shiller is still trying to pursue such a ridiculous course.

Executive pay is way out of bounds in this country. CEO's talk a good game but they only have their own self interests at heart when chosing between them and the company and here is the proof: http://www.pbs.org/now/politics/politics_pop/index.html

I fail to understand how those entrusted to manage our assets can explain how they do not take advantage of the most current tools available. Please read this article and tell me how these managers fail to use these tools!
http://www.pionline.com/apps/pbcs.dll/article?AID=/20081222/PRINTSUB/312229994/1026/TOC

The broader story here is how those entrusted to manage the assets of others can fail to take advantage of all the tools available for optimizing the assets they manage. Please look at this article and explain how these managers fail to use the mose current tools.
http://www.pionline.com/apps/pbcs.dll/article?AID=/20081222/PRINTSUB/312229994/1026/TOC

Derivatives may have a place in the financial markets, but not until the markets are regulated, trtansparent and open. Institutions were buying huge amounts of deravitives without knowing, or even being able to know, the actual contents. Ultimately, they relied solely on the monoline insurance companies to jusdge the quality of the contents. The rating agencies essentially gave high ratings to derivatives because they were insured by monline companies with high ratings. Transparency needs to be extended through the entire chain. Until then derivatives are risky and subject to the whims of someone else with their own agenda. Derivatives will not have a place in the markets until regulation, transparency and due diligence are systemwide. This includes the rating agencies, insurance companies and equity sources.

Hah! It seems to me that we have created investment instruments that are far slicker than we are, and far far too prone to malicious manipulation by priveledged vermin who still today go unpunished!