There is no new money in the derivative monster, just contract
obligations between 2 entities. A zero sum game. However, this
game contributed to the growth of the credit bubble and the
stock market bubble to the sky, since risk premiums and
volatility of various markets contracted.
The same obligations collapsed many credit indexes maybe below
where they should be, and could crash the stock market.
Example: a lot of puts are traded in these markets. The
notional is high, but the cash is being transferred, typically
from put buyers to put sellers. If the markets collapse, then
put sellers will have to pay up, but they won't be able to,
since much of the notional value of the puts will become
real value. Then comes the Fed and protects the system (stock
market) from the "dislocation". This act results in put
sellers always making money, until the collapse happens. How
much money is lost to the system when stock market collapses?
Whatever stocks are worth, and how much they declined.
However, as the market goes down and blows though put strikes,
the market makers will be forced to hedge their puts by selling
the market short in the futures, resulting in a market
crash. This is what happened to credit spreads - and
volatility, which is in some way similar to spreads.
Now currency volatility is on the rise, a danger to carry
trades, quite a big piece of the pie in the derivatives
casino. The key in this derivatives market is the domino
effect, since everyone is tied to the other guy by a
counterparty agreement.
Example: Bear collapses, can't pay 17 billion on contracts
owed to Citi. Citi can't collect, must record 17 billion loss
on their book. Citi collapses. Can't pay their 40 billion they
owe to Morgan Stanley. Morgan Stanley collapses. And so on. |
