Wall Street's Demonic Derivatives

As the markets begin to unravel, the usual suspects will start pointing their tainted fingers at the sub-prime markets; but, sub-prime is only the Genesis of the story. The real devil lies in the fancy financial instruments that the dirty dealers on Wall Street traded called derivatives. The Oracle of Omaha himself, Warren Buffett called derivatives a "time bomb, both for the parties that deal in them and the economic system." Back in 2003, Mr. Buffett infamously dubbed the demonic derivatives as "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

Oh my, here we are sobering-up from a drunken Wall Street binge. Even President George W. Bush said: "There is no question about it. Wall Street got drunk." Then Bush continued by address those nasty derivatives, when he declared: "The question is, How long will it (take to) sober up and not try to do all these fancy financial instruments?"

Junichi Abe Yomiuri Shimbun writes in his article entitled, "Lehman fall exposes fallacy Subprime debacle showed financial alchemy was impossible": Essentially, a subprime loan is just another home mortgage. In addition, it is practically "subprime," not "prime," meaning that the solvency of borrowers in this category is low. Normally, those in charge of loans at financial institutions will not extend loans to such borrowers before closely examining their financial situation, ability to repay loans and their income and assets.

With the magic of financial engineering, a combination of finance and information technology, subprime loans were turned into derivative products, which investors were willing to buy. It was claimed that the product's risk was divided up by splitting the right to claim repayment of subprime loans and securitization, under which subprime loans were combined with other credit.

If this had been true, it would truly have been alchemy, whose goal in days of old was to change ordinary metal into gold.

Yomiuri Shimbun continues by adding: Against the backdrop of the problem is the nature of derivatives products, which are designed utilizing highly complicated mathematical and statistical theories. Therefore, it is difficult even for financial experts to understand their essential nature.

Unable to set appropriate standards to rate derivatives, credit-rating agencies ended up giving lenient evaluations to such products.

Philip Klein from the American Spectator writes in "Warren Buffett Told You So": Buffett seized on the news to deliver a lecture on the danger of such investments, noting the fact that Freddie was a company overseen by a board of directors, the U.S. Congress, and a separate regulatory body, and yet nobody was able to get a handle on them. And he informed the crowd that even the CEOs whom he knew didn't understand the investments.

"I know the people that run these companies and they don't have their minds around what is happening," he said.

And then Buffett predicted: "Some time in the next 10 years, you will have a huge problem that will either be caused by or accentuated by people's activities in derivatives."

The goofy media whores will try to pin this Wall Street fiasco on sub-prime, but that was just the host of the greedy parasites that are thus named derivatives. It's easy to point the finger at some poor guy that can't pay his mortgage or is in hock up to his ears that used his home equity and collateral to stay afloat or do something mindless and silly like Bush suggested after 9-11......go shopping! Get millions of these guys that actually are the real faces behind the unemployment figures to default on their sub-prime loans after the greedy guts on Wall Street repackaged and bundled them off to unsuspecting investors and folks you're looking at the proverbial chickens coming home to roost.

But, the little guy that is now jobless and homeless will get the middle finger from the feds, while the fat cats will find US minted, taxpayer funded golden parachutes. In short, the Republicans suck wind in a big way.

Watch this youtube clip from CNBC’s Senior Economics Reporter, Steve Liesman, who knows and explains the demonic derivative market quite well.