the devil's derivatives_ the un - dunbar, nicholas

[...]... timescales (the so-called yield curve) than the underlying government bonds or deposit rates themselves Derivatives—at least the simplest, most popular forms of them—functioned best by being completely neutral in purpose The contracts don’t say how you feel about the derivative and its underlying quantity They don’t specify that you are a hate-to-losemoney corporate treasurer looking to reduce uncertainty... facade, the real business of banking was rapidly changing One way around the problem was to make more loans but then immediately distribute them to investors in the form of bonds As long as the bonds didn’t go bad immediately, the credit risk was now the investors’ problem, not the bank’s This was the world of the securities firms: Goldman Sachs, Morgan Stanley, and Lehman Brothers The Glass-Steagall... safe as the government, which will repay the money without fail, and pays a “risk-free” rate of interest in compensation Then there is an “insurance policy” or indemnity, for which the risky borrower pays an additional premium to compensate the lender for the possibility of not repaying the loan (although they might have to hand over some collateral) Bundled together, the risk-free loan plus the insurance... who see the world through long-term spectacles The discipline imposed by short-term collateral funding gives investment bankers a profound respect for market valuation They are equally likely to inflict margin calls on others (such as hedge funds) as they are to be on the receiving end of one They live by the sword of market value or die by it Think about owning a bond or loan in this new world The idea... window into the future, had a potent transformational property: the ability to synthesize new financial assets or exposures to uncertainty out of nothing Consider the uncertainty in how companies borrow and invest cash A treasurer might tap short-term money markets in three-month stints, facing the uncertainty of central bank rates spiking up Or they could use longer-term loans that tracked the interest... highlighting the role of the trade press as a cheerleader of destructive innovation With or without the assistance of magazine publishers, the love-to-win mind-set spread like a virus With all the pixie dust—or was it filthy lucre?—these bankers sprinkled across London and New York, who could be surprised that their influence spread? First, it infected traditional bankers (and their hate-to-lose cousins... company does, the question is whether you can afford to stay in the game In this price-driven environment, the spread (the return above risk-free rates) paid by a bond or loan is no longer an actuarial insurance premium for long-term default risk Instead, it is compensation for price risk, which changes to reflect the day-to-day opinion of the market Suppose that after you have relied upon the ratings... That Hate-to-Lose-Money Mind-set Back in the early 1990s, the world’s biggest banks were still firmly rooted in an old lending culture where the priority above all else was to loan money and get paid back with interest Like the small banks on Main Street, USA, these Wall Street banks were run by men who hated to lose money There was just one problem with that fine sentiment: despite the vaunted conservatism... exchange, however, the underlying market was already there, trading billions per day With credit risk, it was fragmented between the actuarial approach and the market approach, and the invention of the CDS provided the market approach with a significant advantage Using over -the- counter contracts with banks, you could trade bets on corporate deaths in complete secrecy, in as big a volume as the banks would... transaction gets rid of the problem Suppose you were based in the Eurozone and borrowed $10 billion at a time when one dollar was equal to one euro If the dollar strengthened to the level of one dollar equaling two euros, the amount of debt in euros would double Fortunately, with a cross-currency swap you don’t have to worry about that because everything is locked in at the one-euro-per-dollar rate What . and came to the closed door of the VIP lounge—which had its own doorman. The door swung open and we continued our way to a low-ceilinged room, the VIP lounge within the VIP lounge. There, sprawled. prostitutes. These young men—and almost all of them were young, some shockingly so—were the avant-garde of the credit derivatives boom, enjoying their first, fifth, or tenth million; outside the door of the. the VIP lounge, the Eastern European blondes were waiting to pounce on them. There are many sobriquets for these young lions, but I like to think of them as the men who love to win. The Moneymaking