Saturday, January 16, 2010

What's So Complicated About Derivatives?

I don't know about you, but I am sick to death of hearing from hyper-educated economists, self-serving politicians, and filthy-rich Wall Street executives just how complex and misunderstood were the factors that nearly pushed the world's economy into the abyss.

One thing that is commonly misunderstood about the study of economics is that it is a social science. That is to say it is the study of human behavior as it relates to resources, their scarcity and, by extension, their cost. Once this axiom is understood, it becomes clear that little more than membership in the human race is required to offer valid or ample insights on the subject.

The 'Maul Street' gurus who survived the cataclysmic meltdown better than anyone else, however, are trying to convince the rest of us that despite this recent little hiccup—okay, near catastrophe—the management of risk is best left to the so-called experts who, conveniently, would be they.

For many years now, Wall Street firms have been hiring young Ivy League mathematicians for the sole purpose of devising new and imaginative ways to increase investment returns. Once upon a time, investment banks were content to put their monies into the kind of financial infrastructure that at the very least had a plausible connection to entities which actually produced goods and services. This, along with conventional banks' old stand-by, housing mortgages, made for a fairly stable banking contingent. Somewhere along the way, however, the concepts of moderation and enough were raped into oblivion, and the worst of human nature became the driving force in the minds and methods of those wielding the most influence.

So what about those pesky derivatives? Forgetting what we already fail to understand on their terms, a derivative is a financial instrument whose value is derived from the value of something else. It is decidedly not something whose value is meritoriously derived by its own intrinsic ability to create honest wealth. Like a pyramid scheme, there must eventually be big losers in order for the short-term-minded prostitutes to prevail. Those who contrived this scheme wanted to reap only the benefits of risk, perverting the much more legitimate practice of chancing modest amounts of capital as a hedge against uncertainty.

Derivatives are only as complicated as we allow those who devise and misuse them to convince us they are. I may not fully comprehend the function of the Federal Reserve, but I know enough about the seamier side of human nature to know that some of us will take what we can and screw then next guy every time, unless of course, we are constrained to do otherwise.

Wall Street: go find your conscience. President Obama: grow some balls. Congress: stand up and change campaign financing laws. American people: nap time is over. Remind these people that the power they derive by the consent of the governed is the only kind of derivative that makes any sense at all.

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