Me either. Them and bitcoins.....do not compute.
Can any of you wiser freepers give a one paragraph basic explanation of what in simplest terms a derivative is?
Put simply, Derivatives are profit instruments created out of thin air as a result of no oversight in the system. The main culprit behind the 2008 crash, Mortgage Derivatives, should never have been permitted.
As proof nothing has changed, anyone can turn on a TV and watch a commercial or news story about how 'housing prices have "recovered"'...aka, "the bubble has returned". That "bubble" is absolutely necessary to preventing the crash of all the GSEs (government sponsored enterprises), for which the Dem Congress removed the cap for bailouts...currently at over $250 Billion.
The finance & real estate yahoos all want us to think everything is 'ok', but the reality is we're all on the precipice, imho. This article is about an accounting trick. The government bailed out the GSEs to the tune of over $350 Billion by some accounts, but no one can explain how debt on private residences generates real income when a house is more equivalent to a 'security' than a 'commercial investment'...the latter of which actually DOES produce a measurable ROI (return on investment)...funny how we ended up with all that debt if houses actually generate income and residential equity has any basis in fact. /s
The Real Estate Market is a house of cards, imho, and the 2008 crash was proof. The deeper causes (Dem policies) are all pretty much history. Due to our GDP being dependent upon consumer spending and home-buying, is it any surprise we're being fed BS on this as well?
That's my understanding; someone else correct me if I'm in 'left field'...
Regardless, what's missed is this article is about European problems with derivatives (CCP defined), not the US. It's been 7 years and the EU is only now implementing European Market Infrastructure Regulation (EMIR) to fix their problems, which were based on US derivatives trading. The article states
Simons added that although models predict that the financial system is currently relatively ‘safe’, the events of 2007, 2008 and 2009 should serve as a serious warning not to become overly complacent.and, imho, that is telling.
A derivative is a contract between two parties, where the value is driven primarily by the price of some underlying physical “thing” like oil, gold, or a stock. The best known derivatives are futures (where you are buying with an execution/delivery date in the future), options (the right but not obligation to buy or sell), and swaps (exchange of two cash streams). Even a sports bet can be thought of as a derivative, as the value is based on something else.
Using the sports analogy, let’s say you want to buy Pats/Colts (i.e., buy the Pats, sell the Colts). The spread is 7, so you would pay $7 and receive in dollars the difference in the score.
Collateralization is a process where the two parties to the contract “settle up” the current value on a daily basis (this is called “marking to market”). In the betting example, you paid $7 to enter into the contract, but the current market value is $7, so I would “post” that amount back to you.
Then, later in the day, ESPN breathlessly reports that Tom Brady has a hangnail, and the spread falls to 3 points. That means your contract is only worth $3 by current reckoning, so you need to return $4 of the collateral I posted.
On Saturday, Andrew Luck sees a GEICO ad and gets really mad, and guarantees a win, causing the spread to go to 2. Now your contract is only worth $2, and you return another $1 of collateral to me.
Then on Sunday, the Colts get Gronked and lose by 18. The contract settles at $18, and since I’ve already posted $2 I need to pay you $16. (I really hope I haven’t screwed up the math somewhere.)
Of course, if I only have $10, then I can’t pay, and you don’t get your money. This is called counterparty credit risk. If my buys and sells are mostly balanced, it’s not much of a problem, but if my position gets too directional I can be exposed. Alternately, if I have very directional risk facing a counterparty who goes under, then we can start to see contagion.
Enter the central counterparty. After you and I make the initial bet, we agree to amend the contract (”novate”) so that the CCP sits in between us, i.e., your long Pats/short Colts position is against the CCP, and my offsetting position is against the CCP. So the CCP is net flat. Two additional bits of information: we will each post a little bit of extra collateral to the CCP (so on day 1, instead of getting the full $7, maybe you only get to hold $5, and instead of posting just $7, maybe I have to post $9, so the CCP holds net $4); and, if I go under, the other market participants are not affected (for the most part — there will be some market disruptions due to the need to “replace” the risk that evaporated, to restore balance to the system).
Hope that helps.