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Derivative Triggered the Financial Terror

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Derivative triggered the financial terror
Jiho Jang

Warren Buffett already said the derivatives “financial weapons of mass destruction.” It’s not surprising. The derivative products have triggered the most destructive financial crisis since the stock market crash in our history. The causes of financial crisis in the late 2000s are still controversial. Some assert that it is just the financial system, and regulation failure and the other insist that resulted from the financial engineering failures. The explosive growth in derivative contracts occurred after 1999 when the Glass-Steagall Act was repealed, which allowed banks to operate as brokerage. Glass-Steagall, adopted in 1933, separated brokerages and banks to ensure banks would no longer be involved in risky transactions. And credit rating agencies were slow to downgrade the credit rating of the securities. Because the rating agencies did not disclose the downgrades in time, many investors were misled to think that securities were still safe to invest in, and it accelerated the market crisis uncontrollably.

The initial intention of derivatives was to defend against risk and protect against the losses and downside. However, derivatives were the most important tools to trigger the financial market collapse. Those tools usually used to take on more risk to maximize profits and returns rather than to defend against risk and to protect against the losses. All kinds of financial products are transferred to the securitized products, which were difficult to price and analyze, were traded and sold, and many investors’ positions were leveraged to reap the highest possible gain. The most well-known derivatives that occurred late 2000s financial disaster are known as securitized financial products, such as mortgage-backed securities
(MBS), Credit default swap (CDS), and collateralized debt obligations...

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