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Saturday, July 14, 2012

Complex Derivatives: Smoke and Mirrors

Derivative: 

A financial contract whose value derives from the value of underlying stocks, bonds, currencies, commodities, etc.
The scam pulled across the world, at the expense of the world, is the financial concept of derivatives - creating profit for the trader by trading value without generating actual wealth. Basically done for the commission, complex derivatives are especially toxic.

Occam's Razor  suggests that elegant simplicity beats inflated complexity. In nature, complexity results from the layering and interaction of simple structures. Complexity tends to conceal the simple parts unless they are examined  closely. Complex schemes are intended for misdirection and concealment. Like glamour, they are illusions meant to impress while the reality lurks beneath. Thus the corruption that was concealed didn't show itself until the system came down around it.

The thing with complexity is that it contains more opportunities for things to go wrong and to be worse when they do. Derivatives encouraged lenders and gamblers to make easy loans without worrying if they were paid back. This caused an inflated housing market which popped, starting the crash and leaving the lenders needing bailouts. This drained national coffers as people lost homes and jobs, reducing the tax base, increasing welfare costs, and creating deficits. Wages were driven down, further reducing the tax base. The gamblers and lenders were losing profit, so they called in their markers on national debts, plunging people into austerity. This means that the people they basically pay the money men twice for the pleasure of fewer services, higher taxes, and no security.

Like complex accounting methods, complex derivatives are a way to confuse and conceal wrong-doing in the guise of advanced acumen. To fool the rubes.