In addition to the concerns surrounding financialization and the risks to the global financial system, the use of derivatives has emerged as a significant factor in the US economy. Derivatives, which are complex contracts derived from various assets, have become a lucrative market for Wall Street banks, hedge funds, private equity, and investment firms. It is estimated that derivatives were worth $600 trillion in 2021, and the trading and selling of derivatives generate trillions of dollars in profits.
The Commodities Futures Trading Commission (CFTC) was established in 1974 to regulate derivatives. However, the 2008 global financial crisis revealed the dangers associated with derivatives derived from mortgages. These derivatives, particularly credit default swaps, allowed banks to shift risk off their books and contributed to the collapse of the housing market. Despite the lessons learned from the crisis, derivatives continue to be traded privately, with many being highly leveraged.
A recent article from NDTV Profit highlights the risks associated with increased derivatives trading in the Indian equity market. The article, written by Sajeet Manghat, points out that the pilferage of incremental household savings has led to a multi-fold rise in trading value and volumes in derivative markets over the last five years in India. Multiple regulators, including the Reserve Bank of India and the Securities and Exchange Board of India, have expressed concern over the rising risk of retail exposure to derivatives. The article also mentions that data on household savings is sketchy, with the last available dataset being from March 2023. [8301e7c9]
The concern for Indian regulators is the rising popularity of derivatives trading among retail investors, presumably for speculation and in ignorance of the risks involved. The article suggests that rules governing how derivatives can be traded should apply to institutions based on their potential to cause systemic risk. The article also emphasizes the need to isolate the hedging intent from speculative intent when regulating derivatives. The article suggests that a light touch in curbing excess speculation, such as adjusting leverage and lot sizes, would serve the seemingly incompatible goals of investor protection and market development. Blunt tools like a higher transaction tax may be less welcome.
The use of derivatives in the US economy raises concerns about the potential for another financial crisis. The Federal Reserve has already reported billions in losses due to commercial mortgage-backed securities (CMBS), the latest form of derivatives. The complexity and opacity of derivatives make it challenging to assess the risks they pose to the financial system. The article from Ms. Magazine calls for increased oversight and regulation of derivatives to prevent fraud and protect against another economic collapse.
Overall, the growing prominence of derivatives in the US economy, coupled with their complexity and potential for risk, underscores the need for greater scrutiny and regulation. The use of derivatives has created a financial system that is difficult to understand and control, leaving the economy vulnerable to another crisis. Efforts to address these concerns and protect against fraud and violence are crucial in ensuring the stability and integrity of the financial system.