The Devil’s Derivatives- The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street

Review From User :

We start at 5 stars today:
+1 star: simplifying things to be understandable by literally anyone, even who has had little education and/or prof training,
- 1 star: some stuff glossed over and/or oversimplified into incorrectness,
+1 star: engrossing read, encompassing a lot of rime and happenings,
- 1 star: a lot of journalism - seriously, who cares how some pal somewhere dresses

Q:
There are many sobriquets for these young lions, but I like to think of them as the men who love to win. (c)
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This rare, often admirable, but ultimately dangerous breed of financier isn't wired like the rest of us. Normal people are constitutionally, genetically, down-to-their-bones risk averse: they hate to lose money. The pain of dropping $10 at the casino craps table far outweighs the pleasure of winning $10 on a throw of the dice. Give these people responsibility for decisions at small banks or insurance companies, and their risk-averse nature carries over quite naturally to their professional judgment. For most of its history, our financial system was built on the stolid, cautious decisions of bankers, the men who hate to lose. This cautious investment mind-set drove the creation of socially useful financial institutions over the last few hundred years. People like that did not drive the kind of astronomical growth seen in the last two decades.
Now imagine somebody who, when confronted with uncertainty, sees not danger but opportunity. This sort of person cannot be chained to predictable, safe outcomes. This sort of person cannot be a traditional banker. For them, any uncertain bet is a chance to become unbelievably happy, and the misery of losing barely merits a moment's consideration. Such people have a very high tolerance for risk. To be more precise, they crave it. Most of us accept that risk-seeking people have an economic role to play. We need entrepreneurs and inventors. (c)
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That kind of confidence-based not on bluster or bravado, but on intellectual analysis and fervent belief in markets-had crept up on the world unnoticed. (c)
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Enticed by the bait of an award, the bankers would open their kimonos and give out details of their deals and the names of their clients-information that normally was a closely guarded secret. That was good. More troubling was the fact that, somehow, the journalist entered into a complicit relationship with the institution. (c)
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Swaps first proved their value in the 1980s, when the U.S. Federal Reserve jacked up short-term interest rates to fight inflation. With swaps, you could transform this short-term risk into something less volatile by paying a longer-term rate. Swaps again proved useful in 1997, when Asian central banks used high short-term interest rates to fight currency crises. Just how heavily traded these contracts became can be gauged from the total "notional" amount of debt that was supposed to be transformed by the swaps (which is not the same as their value): by June 2008, a staggering $356 trillion of interest rate swaps had been written, according to the Bank for International Settlements. As with forward contracts on currencies and commodities, the rates quoted on these swaps are considered to be a more informative way of comparing different borrowing timescales (the so-called yield curve) than the underlying government bonds or deposit rates themselves. (c)
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Lending banks and insurers have typically recorded their holdings of loans and bonds at book value, which is the amount originally lent out, with some allowance for interest accruals. Book value could only be written down when a borrower had defaulted or was clearly in difficulty. (c) That's not exactly true. Provision can be created in many situations.
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Imagine a bank looking to make corporate loans or to own bonds-but without the credit risk. How does it strip out the risk Easy: think of the loan as two separate parts. Pretend the loan is made to a borrower as 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 policy amount to a risky corporate bond or loan. (c)
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As Citibank discovered in the late 1980s, and Peter Hancock learned through J.P. Morgan's Korean bank difficulties, a currency crisis can have the same impact on foreign lenders as a corporate default. That is why weakening foreign exchange rates are a good early warning system that a country and its banking institutions might be unable to repay their debts. (c)
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Before you know it, the salesman has sold you a hedge against your own daydreams. For the salesman, it is the client's dreams, fears, and aspirations that need to be understood and replicated with a specially designed derivative contract
Experienced corporate users of derivatives are wary of this kind of sales talk. Once the conversation turns from the immediate needs of the company-which might be addressed with a standardized hedging product-toward the aspirations of its management, then the nature of the solution can become dangerously bespoke and opaque. But not everyone is so cautious, so impervious to flattery and dreams. (c)
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"I understand your business," Sartori would tell a client. "Can we talk about what's on your mind and what's stopping you from becoming number one What's your strategy" He told me, "That's what I love to ask clients-'I look at your balance sheet and I know what I see, but maybe there's something you're trying in particular to achieve'"(c)


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