The author of this piece doesn't not uderstand how the markets work and why they use derivatives. Derivatives is a zero sum game. No principle is destroyed and no income is multiplied as he falsly claims: "The leverage that once multiplied income will now devastate principal.â In organized exchanges counterparty default risk is minimized by posting margin. The problem with the banking system is that no such organized exchange exists and the only problem is counterparty defaults. This can be solved by the government stepping in and providing funds to the insolvent institutions and this is exactly what they have done. A longer term robust solution to the problem of complex derivatives and synthetic products in general is the institution of a central exchange that will price the instruments and calculate required margins for counterparties to post. It will also be a good business and the income can be used to compat povertry in third world countries, for green projects and other social programs.
No, he is right. Since late 1990s, banks were able to turn derivatives into assets and lend against them. That is why you're seeing assets on the books of the banks simply disappear into thin air.
What do you think MBS, CDOs, RMBS are? What do you think Level III assets were? There is so much information written about this on the web by various writers & bloggers. You take a bunch of mortgages, mix them up, splice them up, put it together into a "new & improved" financial product, get them rated as AAA by the agencies, have AIG insure them, and sell them off. Whatever you don't sell, you place on the books under Level III, which bolsters your assets and hence allows you to lend more. And then you do it again and again, collecting fees & commissions in the process. After all, it's AAA and all guaranteed, right?
Be that as it may, the notionals on these derivatives are a complete red herring. If any of these authors talked about 'market value' or something of that sort, it would make a lot more sense.
For banks, assets are the loans and liabilities are the deposits. A bank can lend against liabilities, not assets. A lot of people have no clue about banking but they insist talking about it.
It is clear to me that half of the damage is not due to the structure of the economy but due to an army of pundits, most of them marxists, panicing people about a coming collapse of capitalism and free markets. The result is people hoarding money and the decrease of consumer spending has made the situation even worse.