Tottering Tower of Financial Derivatives Dwarfs World GDP

World GDP, $63.12 trillion. Amounts outstanding in financial derivative 'products', $788 trillion.

We have not taken nearly enough notice of the crushing, potentially fatal power of financial derivatives, the complex financial swaps, options, collateralised obligations, custom repackaged asset vehicles, reverse dual currency bonds, structured note asset packages, etc, etc, etc.  The prime purpose of these ‘products’ is to make money for the traders and their employers. They have scant connection with the real-world economy, but they tower over us in threatening fashion.

The chart shows world GDP in 2010, courtesy of the World Bank, and the amounts outstanding in exchange-traded and over-the counter (private deal) financial derivatives in September 2011, courtesy of the Bank for International Settlements.

I recommend Satyajit Das’s book ‘Traders Guns &  Money: knowns and unknowns in the dazzling world of derivatives’.  By ‘dazzling’ I think Satyajit means ‘illusional’, ‘delusional’ and downright ‘dangerous’. Unless, that is, the world’s taxpayers are waiting meekly to pick up the pieces, impoverishing themselves in the attempt to prevent mega-bankruptcies in the world of high finance. We all know about the privatisation of profits and the socialisation of losses.

I was prompted to re-read ‘Traders Guns & Money’ (during my first attempt a lot of the financial engineering details went over my head) on seeing an article on the Financial Times website, www.ft.com. Sharlene Goff, Megan Murphy and George Parker wrote, on February 22^nd 2012, ‘RBS bonus cuts offset by big salary increases’.  The gist was that the guaranteed pay of Royal Bank of Scotland’s investment bankers – people who trade in derivatives – was increased by a third in 2011 – to offset the smaller bonuses necessitated by public anger.

Apparently other banks – Barclays, Credit Suisse, Goldman Sachs, for example – have also massively increased investment bankers’ basic salaries to compensate for lower bonuses.

Nothing surprises me about bankers. They assure us that black is white, as in Royal Bank of Scotland’s chief executive Stephen Hester telling us that a pre-tax loss of £766 million in 2011, compared with £399 million in 2010, is a sign of success.  Royal Bank of Scotland Group is 82% owned by us, the citizens of the UK, and so should surely be more responsive to public concern about inflated pay. Agreed that the bank has to offload lots of toxic derivatives (the products traded and often invented by investment bankers) but a loss is a loss, isn’t it? The argument that investment bankers would move somewhere else if their pay were slashed does not strike me as a worrisome threat, because they move around a lot anyway (read Sanyajit Das’s book) and it is their financial engineering that has created the unstable, tottering derivatives tower that may collapse and crush us at any time.

Financial derivatives are Las Vegas on a world-wide scale. Beware.

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