Obama's message to Wall Street to accept the financial reform bill, which would control the trade of derivatives, could be absolutely crucial because the derivatives market is the big time bomb planted beneath the global economy.
What is a derivative? It's not a stock or a bond. It's just an imaginary security that banks trade as a wager on the value of future risk or securities. Understand that? A derivative is just a bet. That's why it's called a derivative – its value is derived from something else, typically another contract, or deal. Derivatives on their own are of no value but they have become the centerpiece of financial markets because traders make billions of dollars every year flogging them. And that's why Wall Street and the banks have had such a vested interest in keeping them untouched.
The problem with derivatives as I see it is that it encourages the kind of risky trades that produced the subprime crisis. If people are shifting risk by placing bets, it makes them more willing to take bigger risks.
As reported here, the derivatives market is currently at around $600 trillion or so. Compare that to a worldwide bond market as of 2009 worth an estimated $82.2 trillion and world economy valued at $58.07 trillion in 2009.
The monster derivatives market is a time bomb waiting to go off with financier George Soros coming out with a warning in the Financial Times that the legislation now before Congress falls short in policing derivatives. All it would take, he says, is for them to be registered but that's not going to happen. Still, the US legislation is a start.
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