Learn The Stock Market Lesson - The Debate About Derivatives
The only thing we learn from history is that we learn nothing from history.
- Friedrich Hegel
In my previous post, I began an introduction on derivatives. If you are unaware about what they are, take a look at my Financial Derivatives’s post to get a better understanding about this post.
If derivatives are so risky, why haven’t we outlawed them?
There have been many arguments between the pros and cons of derivatives. The world’s smartest investor, billionaire Warren Buffett once called derivatives, “financial weapons of mass destruction.” That was in 2002 when he issued his annual letter to the shareholders of Berkshire Hathaway. He continued to say that the derivatives carried danger and, although it was latent at the time, that they are potentially lethal. Few people paid attention to Buffett’s warning and, in fact, many important financial players quickly dismissed his words.
Later that same year, Alan Greenspan, the Chairman of the Federal Reserve at the time, among a few others sent a letter to a couple of U.S. senators, declaring that financial derivatives were not a danger but, rather, they “have been a major contributor to our economy’s ability to respond to the stresses and challenges of the last two years.” They continued to declare that a Senate proposal to regulate derivatives could increase “the vulnerability of our economy to potential future stresses.”
In 2003, Alan Greenspan again defended derivatives, saying that,
“Businesses, financial institutions, and investors throughout the economy rely upon derivatives to protect themselves from market volatility triggered by unexpected economic events. This ability to manage risks makes the economy more resilient, and its importance cannot be underestimated. In our judgment, the ability of private counterparty surveillance to effectively regulate these markets can be undermined by inappropriate extensions of government regulation.”
That’s the good side of the spectrum. Let’s see the bad side: The Enron mess created clear warning signs about the danger of derivatives yet they still contributed to the collapse of Bear Stearns, Lehman Brothers, along with other financial companies. The lack of oversight on derivatives spawned a financial crisis, to which taxpayer money was then used to bail out these financial companies. Don’t forget that the corporate bosses who run these companies are often the same ones who are helping themselves to a multimillion-dollar pay and bonus. Is all of this happening due to our refusal to learn from the past?
