fuse lit on jpms $trillion interest rate swaps, page-25

timber

Why did AIG fail?

What would have happened to the banks that took the other side of the trade with AIG if the US govnuts had not coughed up the money to pay them (via fund injections into AIG) for capital losses under the terms of the AIG insurance arrangements? Look what happens when counter-party risk becomes a concern - the financial system grinds to a halt.

The point is that banks will gamble because they know that they can pass the problem on to others - ie the taxpayer - when things eventually go wrong. Government's are not able to regulate banks effectively against such risk (see USA and UK banking system).

Risk cannot be eliminated. It can only be passed on to another party who may be less informed about the true nature of the risk than those that offload the risk (eg Manly Council or some village in Sweden).

The other main issue with banks transferring their risks onto other parties is that they are essentially able to create more credit money. This simply leads to asset inflation. Those very assets are things on which the derivatives are based. So when there is an economic downturn asset prices fall and impact the derivative contracts. That is why we cannot really afford to have an economic contraction or a popping of the asset bubble.

I am sure you know heaps more about the workings of the derivatives markets than me. Perhaps you are a bit too close to it to make an effort to understand the wider economic implications that these markets have on the rest of the economy.

Why not think about the relationship of the derivatives markets with the real economy, and not just the beauty of the banks' supposed riskless hedging arrangements.

loki