Derivatives Market - Warren Buffett has the right idea.

Discussion in 'Economics' started by SouthAmerica, Dec 29, 2005.

  1. .

    December 29, 2005

    SouthAmerica: I wish that more people on Wall Street and in the US government had a better understanding of the “Derivatives Market”.

    In a Nutshell: Warren Buffett says derivatives are weapons of mass financial destruction.

    Warren Buffett is the world's greatest stock market investor since the 1960’s.

    Quoting from this article: “In 2006, the derivatives market will grow to nearly half a quadrillion dollars (fourteen zeros), more than 10 times the world's domestic product. Even if lobbyists are correct that derivatives are good and are used mostly for hedging, it is unclear why anyone would need to hedge the entire world's domestic product more than once.”


    “Investing in fantasy land”
    By Frank Partnoy
    Published: December 28 2005
    The Financial Times of London

    … Most people assume that markets are dominated by tangible assets such as shares and bonds. But …investors in 2006 will discover a bewildering array of new products, ranging from specialised exchange traded funds to virtual investments that do not actually hold any financial assets, but instead use derivatives to mimic those assets.

    Just about anyone who entrusts money to a fund manager will own some of these products. In 2006, the derivatives market will grow to nearly half a quadrillion dollars (fourteen zeros), more than 10 times the world's domestic product. Even if lobbyists are correct that derivatives are good and are used mostly for hedging, it is unclear why anyone would need to hedge the entire world's domestic product more than once.

    Institutions will continue to buy new forms of hybrid and structured investments, financial animals every bit as strange as the faun and talking beavers of Narnia. Two popular products, so-called "portable alpha" and synthetic collateralised debt obligations, attempt to replicate bond returns without owning bonds. The hot security for early 2006 is called an Ecaps, a crossbreed of shares and bonds.

    Retirees will be in an even more mystifying place next year, where companies and governments that are technically bankrupt pretend they can pay pensioners by making increasingly risky bets.

    According to one view, the central villains are self-indulgent chief executives who will reap oversized option grants, hoard shareholder capital and spurn employees, just as the White Witch belittles her dwarf and wolf servants. In 2006, the average American chief executive will be paid more than 300 times the average employee's salary.

    A contrary view blames activist hedge funds, which force managers to sacrifice long-term corporate interests at the altar of short-term shareholder value.

    Next year, numerous hedge funds will acquire small ownership stakes in companies and demand radical change, just as Carl Icahn, who recently bought 3 per cent of Time Warner, is pressing that company to split into pieces. On nearly 400 occasions during 2005, a hedge fund acquired 5 per cent of a company's shares and filed papers showing it was ready to brawl. During the upcoming year, that number will double.

    People might disagree about which group is evil, but both perspectives highlight the recent structural changes in markets. The issue with CEOs arises not merely from the amount of executive pay, but from its option-heavy composition; likewise, the complexities of modern financial reporting insulate CEOs from attack.

    Who can read the 100-plus-page financial reports of AIG, General Electric, or JPMorgan Chase and say whether those companies are well managed?

    Soaring hedge fund activism arises from the evaporation of other profitable strategies, as traditional arbitrage becomes more competitive, yield curves flatten and markets become less volatile. Hedge fund managers are guided to strike at corporate managers, not by any moral sentiments, but by Adam Smith's invisible hand.

    The central question for 2006 will be whether shareholders are better served by hedge funds, which seek short-term profit, or corporate managers, who consider long-term value. It is a new, more sophisticated spin on an old problem: in whose interest should the company be run?

    Anyone who sees markets as driven primarily by economics will favour hedge funds and will see companies as mere financial instruments that are useful only to the extent that they generate profits for shareholders.

    Anyone who sees markets as essentially political will favour corporate managers and will see companies as an amalgam of constituencies - shareholders, employees, customers and community - whose competing interests require the skills of an astute mediator.

    For anyone who likes not only to invest, but to think about investing, 2006 will be a year of enchantment and mystery. There is a deep magic at work in the financial markets.

    The writer is a professor of law at the University of San Diego and a former banker at Morgan Stanley. He is author of Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt/Profile)

    You can read the entire article at:


  2. .

    December 29, 2005

    SouthAmerica: Quoting from the above article: “In 2006, the derivatives market will grow to nearly half a quadrillion dollars (fourteen zeros), more than 10 times the world's domestic product. Even if lobbyists are correct that derivatives are good and are used mostly for hedging, it is unclear why anyone would need to hedge the entire world's domestic product more than once.”

    I wonder if anyone is considering what kind of damage the General Motors bankruptcy in 2006 will have on this “House of Cards”?

    When GM files for bankruptcy in 2006 – that will also affect a lot of other corporations – what will be the combined effect of these events on the derivatives market?

    That probably will be a lot worst than the impact that 9/11 had on the stock market.

    It doesn’t matter what the yields on 10-year US Treasuries are trying to say to the market.

    The Fed has to keep increasing the Fed Funds rate to at least the 5 percent level, because of the value of the US dollar.

    You can bet on that!!!!!!

    2006 will be a very interesting year, but not good for the stock market.

  3. Biased socialist rubbish. "If only enlightened socialist elites from California applying the scientific method were in charge we wouldn't need of of this money grubbing"
  4. The basic premise of derivatives is that for every contract their is an equal and opposite contract in place. So in essence, the total long positions are balanced by the total short positions. In effect the derivatives market hedges itself. For every loser their is a winner. It's a self balancing financial mehcanism.

  5. Excellent Commentary

    Capitalism as defined by stock...again reflects a lot of false value in that businesses future revenue streams are multiples of flow etc...

    However...the physical assets of companies ...when the financial flows to the company cease...reflect only a small fraction of the previous stock one can reference in GM...

    When you add further leverage such as derivatives...the total leverage is even to the true value of the physical assets...physical assets will be a very small percentage of value...

    There is an incredible amount of make believe value in stocks in the capitalist game...when you add derivatives...this inflates the make believe values many times over...

    Stock values as represented by indexes are a fraudulent representation of what actually happens in the true stock market...

    There is no true stock index...a true stock index would include all values of companies ...all that succeeded...all that failed....
    It could be that when all stocks are accounted for...a true index would actually represent continuous declining values...

    When you combine the fact that there is no true stock index...and you add derivatives to the mix...The true representation of actual real value becomes fairytale land...

    It is much like diamonds....little stones that cost a lot of money...whose real value is imaginary...and real...


    What one can say is that capitalism sometimes creates an incredible amount of temporary value as represented by the company name...


    Long live the stock market vaqueros !!!!!!
  6. jem


    Now I have to stick up for my law school and my old town. San Diego is not liberal. There are a few liberal sections but overall it is is conservative.

    USD school of law is not liberal. It is mixed with professors from Harvard and Chicago.

    They also produced many conservative/libertarian (not neocons) grads. Actually plenty of them.

    The beginning of the article is correct. The derivative markets is very scary. Even if Running bear is right and its zero sum. I do not want places like orange county getting wipe out because they got the downside of their derivative in a bad way.

    The end of the article got a little fuzzy. Why should I have a problem with hedge funds buying stakes in companies? Especially poorly run ones.
  7. Lost some money in derivatives recently ? :)
  8. jem


  9. I agree with you for the most part but it is important to point out that many contracts are very asymmetrical. Consider as basic put or call contract-unlimited versus limited upside or even your car insurance. This is why there are trading desk to insure risk and then spread it out. It is a conscious effort not a self-adjusting one. It also very important to note that insurance, derivatives and trading is not a zero sum game. By shorting that euro future you enable a exporter to hedge there cash flows. This certainty allows the exporter to get a loan, start a business and grow the economy.

    There is a big difference between betting what card will come up next and using your capital to offset a risk that someone occurs as a normal part of business.
  10. Cesko


    Guys, go over Southamerica other posts. Pure propaganda ,nothing to do with actual trading. Stupid commi.
    #10     Dec 30, 2005