Watch to learn about financial derivatives and the part they played in causing past recessions.
What Is an 11-Letter Four-Letter Word? – Video Transcription
Coy Wells: 00:00
If you're worrying about a repeat of the 2008 recession, you're not alone. Anxiety about a new recession is on the rise. You may ask, would something so dramatic happen again? Haven't the banks changed their practices since then to prevent repeating such an outcome? Not as much as you'd hope, especially in one key area. Derivatives, a derivative is a financial contract between parties regarding the price of an underlying asset. Essentially it is an agreement to sell that asset at a fixed price in spite of changes of the market price. A derivative then attains its value from changes in the value of the underlying asset. Typically, derivatives are not traded on the exchange but are instead used by banks and other institutions to hedge risk. The bigger the reward that can be acquired from a derivative, the bigger the risk; like gambling at a roulette table. If an institution places a lot of money on a derivative hoping for a big payout, they may expose themselves to taking a bath.
Coy Wells: 00:59
Many of the largest banks in the United States are betting heavily on derivatives top banks such as JP Morgan, Chase Bank, Citibank, Goldman Sachs Bank, Wells Fargo, Bank of America, and many, many more have hundreds of trillions of dollars in derivative exposure. This is despite a lengthy history of derivatives building on a bad reputation over time. In 1995, chairman of the American Stock Exchange Richard Syron called derivatives, “The eleven letter four-letter word,” due to troubles they caused in the previous year of 1994. In 2003, Warren Buffet called derivatives weapons of mass financial destruction in a letter to Berkshire Hathaway shareholders. In 2008, financial crisis derivatives were a key factor. Institutions like the infamous Lehman Brothers lost big on their bets on credit derivatives. These losses spider webbed outward and rocked the entire market. For a more in-depth understanding of past recessions, I want you to call the number on your screen to receive U.S. Money Reserve's latest special report U.S. Stock Market Crashes: Lessons from the Losses. This report will provide in-depth coverage of the causes of previous market crashes. Please click the link below or call the number on your screen to get your copy today. If you find this has been useful, please comment or share this video. If you're watching us from YouTube, please subscribe to this channel so you don't miss a single episode. I'm U.S. Money Reserve's Coy Wells and thank you for watching Market Insights.