Derivatives are Not Evil

Are Derivatives Really to Blame?

Derivative securities are not inherently evil, though the media would have you think otherwise. It seems that any

Are they evil?

type of investment that does not directly involve commodities is an easy target these days.

But derivatives are just another type of investment, those whose value is derived from some underlying security or asset or event.   Insurance is a type of derivative investment, as a matter of fact. If the bad event happens (a car accident, flood, or fire, for example), then a claim is made against the policy.  If not, the policy expires.   The value of the policy is derived from the insured asset or event.

If derivatives are bad, then so too is insurance.  If derivatives are bad, then so too are leases with the option to own.  If derivatives are bad, then so too is the equity in any type of company, small or large, private or public, including those that produce real products and commodities, for stock is nothing more than an option to buy the underlying assets of the company for the price of the face value of its debt.  If derivatives are bad, then so too are convertible securities and most every other type of financial innovation we’ve witnessed in the last 30 years, and for decades to come.

by Sherry Jarrell

9 thoughts on “Derivatives are Not Evil

  1. There are many types of derivatives. To describe them as insurance or equity is inappropriate. Derivatives have existed for 5 centuries, in Japan, China, and Europe. They existed for about a century, in connection with the future prices of farm products, in the USA, in Chicago. In all these cases, they were appropriately provisioned contracts.

    Not so anymore today. Under Rubin and Summers, plutocrats serving themselves and their kind, under the uneducated puppet in chief Clinton, derivatives were allowed for anything whatever, in all and any ways. A market of these derivatives was made, consisting in bets among banks and hedge funds about how things will go. This “market” became as large as twenty times the entire world economy.

    To say that “If derivatives are bad, then so too is the equity in any type of company, small or large, private or public, including those that produce real products and commodities…” is revealing: the author admits implicitly that derivatives produce nothing real. Question: can we afford to have all the world free capital producing nothing real?

    When 300 billion of mortgages defaulted, up to 24,000 billion dollars of derivatives were potentially lost, in the USA alone (Europe has its own derivatives too).

    Insurance without any funds to pay for it is pure theft. This was the case of Credit Default Swaps. The taxpayers were left with the bill. The plot between Goldman Sachs and AIG was nothing more than planned robbery, and the government, represented by Paulson, past chair of Goldman, seconded by Geithner (who is paid by the banks), played its role.

    Derivatives such as naked shorts are little more than taking fire insurance on the neighbor’s house with the ability to set it on fire in all impunity.

    Derivatives ought to be allowed only when safe, and effective, for the people engaging in these contracts, and for the system at large, which is the entire world economy. The world cannot function when the derivative is twenty times bigger than the real thing. Those who do not understand that ought to take the most basic calculus class imaginable.

    I understand, though, that the incredible leverage provided by derivatives has created an entire corruptocracy, from financiers to their valets teaching the wrong notions to the young and naive. They don’t need to know calculus: being dominated by greed is enough.


    1. I just want to warn any reader that Patrice, in addition to misquoting and mischaracterizing my post, fundamentally does not know what he is talking about on this topic. If you have any questions for me, I’d be happy to explain, but I refuse to waste any more of my time trying to engage Patrice in any meaningful dialogue. It is truly hopeless.


      1. I do know what I am talking about. Just an example. The fact is AIG had sold around 180 billion of Credit Default Swaps, for which it had made no provisions. This was an insurance against the default of some credit instruments, but AIG had no money to pay said insurance. Instead the US taxpayers had to.

        I notice that Sherry “refuse(s) to waste any more of my time trying to engage Patrice in any meaningful dialogue”. More misquoting and mischaracterizing of mine, no doubt.

        Germany and her conservative Chancellor, Angela Merkel, a lady of substance, a former PhD physicist, has just outlawed some types of derivatives as dangerous to German national security.

        Here is a quote from another site:
        ” Webster G. Tarpley
        May 19, 2010
        Germany and Europe have now made some promising initial steps in the direction of their necessary self-defense against the depredations of those zombie banks and hedge fund hyenas who have been organizing a massive speculative attack on Greece, Spain, Portugal, and Italy with a view to destabilizing the euro and perpetuating the world hegemony of the troubled US dollar.
        The most significant of these moves is the ban imposed unilaterally by the Merkel-Schäubele Christian Democratic-Liberal German coalition government to outlaw the use of high risk derivatives, specifically credit default swaps (CDS), for the naked shorting of government bonds which are denominated in euros. This means that Europe’s largest economy and the Frankfurt financial center – the biggest in continental Europe – will be off limits for speculators using these toxic CDS, which are issued by entities which have not fulfilled the legal requirements for underwriting insurance. This website has repeatedly urged a ban on credit default swaps.”

        It seems to me that Sherry is disparaging me, and not respecting a modicum of intellectual debate.

        But having just listened to Glenn Beck and hours of his lies, I am in no compromising mood. I have long studied the Nazis, and I know their propaganda tricks. Character assassination and the technique of the big lie are central.

        Patrice Ayme


  2. Oh, it just dawned on me that some readers may be unaware that Credit Default Swaps (CDSs) are a form of derivative. They are. The 180 billion lost by the taxpayers with AIG, just an example. AIG is not even a bank, but an insurance company. 13 billion of the taxpayer money went back to Goldman Sachs, an accomplice of AIG, constituting its entire “profit” for the year. Thank you, taxpayers! Goldman Sachs cash register rings for you.

    Also Germany outlawed naked short selling of financial stocks, another financial gimmick to rob the world of capital so as to fill-up the pockets of the few and unworthy, for useless pursuits, but the thrill of evil enjoyed.

    I guess me and the Germans do not know what we are talking about.


  3. I wonder where Sherry’s money comes from. I wonder if she has ever been engaged in producing a tangible good or providing a non-FIRE, non-gaming industry service, sweat of the brow kind of thing or is she just used to spending others’ money. I would like to know Sherry IYO, When is a so called investment really just placing a gambling bet? At what point does an interest percentage constitute usury and when, do you think, will financial “growth” strangle a finite resourced world?


    1. Goodness! Spending other people’s money? That would be the government, not me!

      Yes, I’ve worked my tail off since I was about 8 years old in every type of job you can imagine, working in industries with both tangible and intangible goods! I don’t come from money and I’ve always had to support myself. I am not sure why that’s relevant but to the extent it makes my observations more credible to the readers of LearningfromDogs, I’m happy to share it.

      The way I see it is as follows: Any investment, including going to school, learning a trade, or buying an option, involves uncertain future returns. No one knows the future; no one can control the stock price’s reaction to news. The difference between what you spend and what you get is the return (which is easiest to measure when it involves dollars but by no means does it have to be a purely financial investment).

      The best way to determine the expected return on an investment is to translate all its fees and rates into the number of dollars. An example is telling, and gets to your point about usury: Say you went into a Cash Advance store to get your $2000 income tax refund 3 months early. For that service, you are charged a 10% fee, or $200. Sounds reasonable? Well, that $200 represents a 3-month interest rate of 11.11% ($1800 = $2000/(1+r)), and an effective annual rate of a whooping 52.4%! That’s usury! Car leases are next!

      Regarding the youtube on the mathematics of growth: the link is much appreciated. I think most folks will learn something interesting that they did not know before. But keep in mind that the speaker makes a very narrow point and tends to overlook the fact that growth is the result of buyers and sellers voluntarily transacting to secure goods and services that, in the participants’ view, makes their lives better, and that a pricing mechanism (generally made less informative by interference from third parties, including government taxation and regulation) naturally limits and rations supply and demand. Growth is caused by economic behavior; the video makes it sound like growth is inevitable,i.e., that today’s growth causes tomorrow’s growth. The reference in the video to President Carter’s observation on energy consumption, for example, ignores the fact that the rising price of energy will increase supply and lower demand, which reduces the rate of consumption growth.

      by Sherry Jarrell


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