'Did Derivatives Cause the Financial Crisis?' - Ed Murray: 3CL Lecture

okay I think that it's about time we started can I welcome you all here tonight I'm Sarah Worthington for those few of you but they're not very many of you that I've not yet met I'm slightly less new than Ed Murray but I've been here since October and very pleased I am to be here but more pleased to welcome you to another of these 3cl private law seminars this one sponsored by 3cl where we have ed Murray who's a partner at Allen & Overy speaking to us on did derivatives caused the financial crisis a practicing lawyers perspective I want to tell you a little bit about ed before I hand over to him he is on and ovaries global relationship partner for is des is there is the International Swaps and Derivatives Association about which no doubt will hear quite a lot tonight and a senior member of our and over his team which has gorgeous Esther on their global activities he's chairman of is this financial law reform committee which coordinates is does lobbying efforts with international organizations European institutions and national authorities he's a member of the Bank of England's financial markets law committee currently chaired by Lord Hoffmann and a member of the prime finance the panel of recognized international experts in finance currently chaired by Lord wolf would Sarah is a member he he could have gone down such a different route because after he left school what he did was philosophy at Trinity College Dublin and emerged with the top degree of his graduating class and then look what happened he qualified in the US and in England and Wales as a lawyer and is where he is there's a bit too much is there I think in the background for him to give us an unbiased answer to the question that he set himself but he has promised that he will try to so I'll hand over to him and he'll speak for about 45 minutes and then give you time to ask questions so enjoy Thanks thank you sir yeah I was assuming that once you'd heard the bio you would know where I was coming from but I will do my best to give you what I think is the right perspective on the role of derivatives in the financial crisis at least my view of the correct perspective of balance I hope advancement but I'm I I would be delighted of course if there is a discussion and if people wish to challenge my view or express different views etc etc now I'm you may know that Warren Buffett sometimes referred to as the sage of Omaha famous investor famously referred to derivatives as financial weapons of mass destruction in his annual report to shareholders of Berkshire Hathaway in 2002 so quite a few years before in fact Lehman's collapsed and more recently the Nobel prize-winning American economist Joseph Stiglitz in an article in The Guardian blames OTC derivatives and specifically credit default swaps for if not causing at least severely worsening the behavior whether severely worsening the sort of the sovereign debt crisis at least in relation to Greece and of course it's been you know there you could cite many other examples of politicians academics journalists and others lawyers even outside my area who you know have pointed at derivatives as either the chief villain or one of the chief villains in relation to the financial crisis so I just want to look at that and and just give you my perspective as someone who's been involved in the derivatives industry pretty much since the beginning of my career I've been counseled his distance 1994 but in fact I started my practice in New York in 1985 and began to be involved in his two working groups from 1986 now history itself was founded in 1985 so my mother was virtually in at the beginning of his de and the swaps market itself only been around at that stage about five years so well first of all when we're talking about you know the derivative is the row of derivatives in the financial crisis it is helpful to distinguish different phases of the financial crisis and so I'm broadly speaking dividing it in it into two parts one part is the banking crisis sort of roughly 2007 to 2009 now I'm not saying you know we're entirely out of that that crisis stage but I think that you know it's generally recognized that the worst of it the most serious the most calamitous events to date at any rate we may have a further part of course one doesn't know but the worst of that was probably the 2007 to 2009 period and of course in the middle of that was the collapse of LeMans in September 2008 but then also more recently the sovereign debt crisis broadly speaking you know over the last year or two to present and I say you've heard my that you know what what my professional background is and and and the extent of my involvement of the derivatives industry I think one of the reasons why or rather the people who tend to point accusing figures fingers at derivatives often are quite loose or an exact imprecise as to what they they mean by derivative or what they think a derivative is so I think it is actually important if I just for a few minutes go through what I think a derivative is hopefully when you understand the nature of the product it's a bit easier to see how it might what sort of role that might have played in the financial crisis and by the way I'm not going to make any mystery of of what I think the answer to the question is did the financial derivatives cause the financial crisis I'll give you the answer right now my my belief is that derivatives did not cause the financial crisis but they did considerably worsen it in other words they had an important role to play in the financial prices so that is that's the perspective I'm coming at and I think it's important understand what derivatives are how they work so that you can see what sort of role they played in the financial crisis and then you can get I think a more balanced view as to the kind of role that they may have played now sorry if this is really basic if do you all know what a derivative is well let me give you my my my take on it I think it's helpful first of all to have a basic definition which is a derivative is a transaction that derives its own value from changes in a reference value that's the sort of if you like the kind of a generic definition that I think captures pretty much all derivatives and so it's a transaction that derives its own value from changes in a reference value now the types of reference values could be prices of assets trading in an underlying market either directly equity prices bond prices commodity prices or via an index because indexes financial indices commodity índices tend to represent a fluctuations in underlying prices but if you like at one removed via the index so you have financial assets trading you have commodity assets trading so financial derivatives commodity derivatives but you also have other variable measures of value which could support a derivative contract inflation freight rates rainfall temperature bandwidth etc you have derivatives on all those things so that would be a topic for another talk as to how you actually write the weather derivative but the key thing is that each of these types of transactions has a value a commercial value that value is derived from the value of assets trading in an underlying market in a sense or some equivalent fluctuation in a measure of value now that's the generic definition but let's look at more specific examples but before we talk about derivatives consider the most basic type of commercial transaction a sale so a baker buys 50 bushels of wheat from a farmer at today's price of 10 euros per bushel for immediate delivery it's the most basic type of commercial transaction now consider the exact same transaction with the one difference that instead of the wheat I mean it's it's 50 bushels of wheat it's an agreed price but instead the wheat being delivered today it's delivered in nine months time now the only difference between those two transactions is the introduction of time and yet that second transaction is a derivative so you know a derivative it's called a forward and a derivative is created very simply it's a very simple type of transaction which is created simply by deferring the time of settlement now what is deferring the time of settlement do it introduces risk at any rate it introduces risk if the item that is to be delivered fluctuates in value so I'm you know I'm assuming that we're talking about an asset that fluctuates in value wheat prices go up and down so for purposes of my example risk is introduced because the delivery is postponed for nine months now why is risk introduced because in nine months time the market price of wheat may be above or below whatever the price was that we agreed that the farmer and Baker agreed to pay today so if week prices go up in nine months time who is the winner under that forward the purchaser because the purchaser is locked in a price that's lower that bhaiyya sumption than the market price and of course if prices go down who's the winner it's the it's the form of the seller because the farm the farmer has locked in the price now why would these parties do this type of transaction they would do it because in nine months time the the the farmer knows it will have wheat he will have wheat or she will have weed to sell and the Baker knows that he or she will have week that they'll need to to get into Grimes produce it to flower I'm assuming this this Baker is kind of an all-in-one type of business you grind milling his own flour and then and then baking goods but the key thing is one of them wants to ensure a minimum income one wants to insure a maximum cost and they're both concerned about fluctuations prices of wheat so actually they're both hedging but it's otherwise a very simple transaction now imagine the same transaction but instead of the parties agreeing that in nine months time there will be a delivery instead the Baker simply purchases the right to buy 50 bushels of wheat from the farmer at today's price today's agreed price let's say it's eight euros per bushel for delivery in nine months time now the Baker won't exercise that option obviously unless the the price is above you know the market price is above the agreed price and so there's no upside if you like for the farmer the farmer doesn't get the benefit if the price if the market price falls below as it would do under forward so the farmer has to be compensated upfront with some sort of option premium some sort of option price to take that one-sided risk similarly the farmer might decide to buy an option from the baker to sell the wheat so just the the farmer says in nine months time I'd like to buy the right to sell the link to you at an agreed price and so where the where person's buying the right to purchase that's called a call where they're buying the right to sell that's that's called a put hopefully though you can see that both those types of transactions are actually not muck far removed from an ordinary sale now let me round that off by saying every derivative is a forward or an option every single derivatives afforded option or a combination of one or more forwards and options well well that's it that's it basically so in other words at the heart of every derivative is a very simple idea so you know in other words derivatives aren't intrinsically complex now of course if you combine several options and forwards I mean you do get options on forwards and so on and so forth then you get complexity but the core ideas involved in derivatives are relatively simple now let me quickly relate those to other terms you hear you've heard the term swap well perhaps just in view of the time I just take it as read that a swap is a series of forward contracts a future is a forward contract traded on an exchange you get you have transactions called cat collars and floors those are variations on options except that typically a cap is a series of puts a floor as a series of floors a collar is a sort of combination of a cap and a floor over a series of settlement periods and so on so say every derivative is a forward or an option or a combination of one or more forwards and options and if you thought about my example of the options you'll probably have realized by now that every forward can actually be broken down into two options because a forward is nothing more than the baker buying an option to purchase wheat and a farmer buying an option to sell wheat where they've agreed the same strike price so in other words every forward can be decomposed into two options which means that in fact is really only one building block is that which is the option at least you know sort of basic economic substance that's overstating it because in fact when you put the two options together forward sort of behaves in ways that you know individual options don't behave and so on but it's still very interesting to know that you can decompose any forward into two options and if we have more time I could give you some actually practical examples of my own practice were that knowing that has actually made a difference the other thing you sometimes get is you get a hybrid of a derivative with something else so an equity index length bond is basically a debt security with an embedded option of some type or typically or forward so it's sort of hybrid now one of the things to know about hybrids is sometimes people point to that those and say that is a derivative well it's well that's only partially true and so one has to be a bit careful again as to you know how widely we draw this the set derivatives when we're trying to decide what sort of actions we need to take to ameliorate the potentially negative effects of derivatives in in addressing any potential solutions for the financial crisis so another thing to bear in mind about derivatives is that a derivative is a financial transaction but it's not a financing transaction so if you think about the forwards neither the baker nor the farmer was actually raising money there's no raising of capital in a derivative pure in the pure sense so it's not a financing transaction it's it's not about raising funds raising capital neither parties borrowing it's about allocating risk now there can you risk the weak price to go up and down or bhangra a bond price will go up and down or an equity price or whatnot so it's a risk allocation mechanism and that's obviously important when we look at the role that road has played in the financial crisis let me give you some statistics now thesis I'm sorry these statistics are a little bit old but as a sort of ballpark figures they're still fairly accurate this is the least that these statistics are from December 2010 and they're published by the Bank for International Settlements now in December 2010 the BIS estimated there was approximately 600 trillion of notional value of derivatives outstanding at the time that breaks down into four hundred and sixty five trillion of interest rate derivatives so about 77 percent of that total is interest rate derivatives for the nine percent currency derivatives about five percent credit default swaps less than one percent equity derivatives less than half a percent commodity derivatives and then there's sort of an unallocated group I don't know what's in that but presumably that's more exotic things or hybrids longevity swaps maybe in their weather derivatives maybe in the unallocated bit that's about six percent but 600 trillion which is a scary number is actually only notional value that doesn't it's a misleading figure in the sense that the notional amount of sale a swap is actually a measure of the risk that's being hedged by that swap it's not actually a measure of how much risk a party to that contract is actually bear as a result of entering into that contract the the market exposure under the contract itself if you compare the 600 trillion the actual gross market exposure according to the is represented by that 600 trillion in notional now is only 20 trillion that's still a big number 20 trillion but 20 train is a lot smaller I would suggest that 600 trillion so 20 trillion is actually the gross market exposure in the derivatives market and then if you apply something called netting which again would be the subject of another talk but most of the market have netting arrangements in place either by contract or via the rules in exchange and here we're actually looking figures for the off exchange market but if you once you've applied netting that the BIS estimates that that mark exposure comes down to about three trillion one of the things though I want to emphasize about those figures is that the vast majority of OTC derivatives our interest rate and currency and we don't really read much in the way of articles about the dangers of those and no one has seriously suggested that those are in some sense at the heart of the financial crisis or at least you know I mean there are sometimes people politicians who call for a ban on all OTC derivatives and but that would that you know that sort of bald statement that sort of bold demand would encompass you know a huge volume of vanilla allocation of risk in the financial markets which you know efficient financial market suggests adds value to or rather as it is an efficient way of allocating risk within those efficient tools for allocating risk within those markets but the one type of derivative that has attracted a certain amount of negative publicity is our credit default swaps now as I said credit default swaps account for about 5% of global volume in at the end of 2010 so let's look at what what a credit default swap is in a little bit more detail a credit default swap is effectively a put option despite the fact that it's called a swaps not really a swap and that could explain to you you know maybe in the Q&A why they call them swaps they're really not swaps they're they're they're actually a type of option and it's actually a put it is the right of a protection buyer to sell corporate debt to a protection seller in certain circumstances the contingent right so it's a contingent put its contingent on the occurrence of a so called credit event in relation to a reference entity and a reference entity could be a company if it's a corporate c.d.s it could be a sovereign such as Greece or Argentina it could be some other type of assets such as a well I'll come on to this lady more complex example of a moment so examples of credit events which would give rise to the right to sell to exercise the put by selling the corporate debt would be a failure of the reference entity to pay some of its indebtedness a bankruptcy of that reference entity or restructuring of the debt of that reference entity and so with sovereigns who have similar types of credit events fail to pay repudiation moratorium restructuring the strike price of that put is the par value of the debt the so what happens is bankruptcy occurs the protection buyer puts the debt so they're entitled to get paid par value for debt that's worth a fraction of par because of the bankruptcy of the company and one thing I haven't yet mentioned but but we should have been well now is that any derivative can either be physically settled ie by delivery of wheat or by delivery of debt or whatever the underlying asset is or cash settled now if it's cash settled then typically that means simply looking at the market price looking at the agreed price the strike price or whatever and then paying the difference so in the in the Baker farmer example what you could have had is in nine months time instead of the farmer delivering wheat and the Baker paying the price of that wheat if the price were above the agreed price the farmer could just pay that difference between the contract price and the market price to cash settle the contract and of course if the price were below the agreed the market price were below the agreed price the Baker could pay the farmer that difference which is one one of the reasons why sometimes the cash settled derivatives are called contracts for differences but economically the two you know leaving aside transaction cost economically the two types of settlement of the same they have the same value for the for whoever benefits and indeed the same negative value for whatever bears the liability that's important in all sorts of contexts so the CDs market started off as a physical delivery market in order to exercise your protection you delivered the debt but what happened when a few years ago auto parts manufacturers and technology start ups etc started to go into bankruptcy it was that the markets discovered there wasn't enough of the debt around to actually settle all the outstanding contracts so those contracts then became cash settled contracts and única long story short the cash settlement price that was determined by an auction process so in those instances the protection seller effectively just pays the difference between the par value of the defaulted debt and the agreed value determined but pursuant to the the auction value so you can see how it fits into the category of a contract for difference of cash settled a cash settled derivative now a CD s can be written on corporate debt so your corporate CD s corporate default swaps sovereigns it can also be written on securitization or structured financing debt and that is really where CD s begins to appear in the financial crisis and so in order to explain how CD s made a bad situation a lot worse I now need to say a few words briefly about securitization of structured financing now strictly speaking a securitisation either securitization or structured financing is a derivative although they often involve derivatives but you can actually put together as a securitization without a derivative and cite it isn't necessary in other words it isn't sensual at least to a classic securitization to have a derivative involved typically there are derivatives involve for reasons all I mentioned in a moment but you don't have to have one involved now there are however something you may have heard of called synthetic securitization synthetic securitization does at its heart have a derivative and synthetic securitizations were crucial to the worsening if you like or the expansion of the financial process but let's just look briefly at what we mean by structured financing or securitization float for present purposes I'm going to treat those as synonyms I mean they're broadly similar techniques and maybe again during the Q&A if if it's people feel it's relevant we can press distinguish between securitization structured financing but broadly speaking what we mean by that is that someone an originator let's say a bank takes a portfolio of debt sets up a special-purpose company usually called a special purpose vehicle in SPV and then sells all of that debt or that portfolio of debt to that SPV now where does the SPV get the money to to pay for the debt it issues securities into the market to investors who and then it uses the proceeds of the securities issued to buy the debt now this is a way in which capital markets investors can't it can take on risk in relation to types of debt that otherwise are only available to bank lenders for example or other types of lenders that's why it's called securitization we've turned other types of debt like corporate loans student loans credit card receivables trade receivables you've turned them into securities which capital markets investors that can invest in why would capital markets investors want access to that that type of debt well really just that the search for higher returns because a lot of times of those types of debt are riskier and therefore by you know they the the security's representing that risk carry higher rates of interest now the what was the role of this technique of securitization in the financial crisis well in that in the financial crisis of 2007 to 2009 that that sort of period when when things really started to go bad and which of that period is well chronicled in a number of books but one particularly fun one to read I suppose is the big short by Michael Lewis but there are some perhaps slightly more serious ones the you know I think the the general story goes that the real toxin that is at the heart of the financial crisis was residential mortgage loans made to borrowers in the US on rip on rediculous terms up to and beyond the value of in many cases of the actual mortgage property so that you know on any sort of sensible measure you know money was being led to people who couldn't couldn't repay it and that toxin was distributed through the financial system via securitization and structured financing so a dodgy residential mortgage lender would accumulate a portfolio of almost worthless loans made to borrowers with no hope of repaying them and then the lender would transfer all those loans to a special purpose vehicle the SPV would issue securities get in investors money and and then you know pay that you know in effect take the these worthless assets from the the lender of course I'm slightly exaggerating oversimplifying for dramatic effect but I mean broadly speaking that is how to the toxin entered the system now why would investors lend to such an SPV because they misunderstood and/or were misled misled as to the nature of the the risks in that portfolio because they believed that actually that portfolio of debt wasn't as bad as as it sounds but there was also a belief that somehow the structure of the debt issuance alleviated some of the risk via technique called trenching so how does that work well in these securitizations typically the security is issued by the SPV or issued in different classes and that sometimes referred to as the capital structure so there would be an equity class and then an unrated subordinated class and then maybe a triple B class at double-a class a triple a class and then actually there would be a class above that believe it or not double a triple a plus sometimes called super senior and it's been a while since I've looked at these precise figures but I think in terms of order of magnitude the equity bit 98% on unrated subordinated debt might be about 10% five to ten percent trip will be 3 percent double a three percent triple a six percent so 70 percent of the capital structure might be actually better than triple a according to this structure now what are these what are these mean what do I mean when I say it's better than Triple A for seven well the way the tranching works is that if there is a loss in the underlying portfolio it's agreed that the party that holds the equity piece will suffer the loss first and the you know and only until the losses accumulate to the level where they equal eight percent of the capital structure when eight percent in other words of the debt issuance has defaulted only at that point will there be any deduction from repayment in relation to the higher tranches and so you and so you roll on up through the the capital structure you know the losses then hit the next tranche and then the next tranche and then the next tranche and the ratings assigned to the tranches reflect the view of the rating agency that you know the risk of the triple-a trans is triple in it you know that the likelihood of default is very small and when you've analyzed that bit then of course everything above that must be then better than triple-a hence super senior now in super seeing is better than US government at least you may remember there used to be the days when the US government was a triple an and a og had masses of that Triple A of super senior debt sorry and but of course if the whole portfolio is bad if your assumptions about the credit worthiness of the portfolio are completely wrong because you've misunderstood you've missed analyzed the risk then in fact you know that's so-called better than triple a risk is actually much riskier and yet because AIG purchases at a time when it believed it was better than triple-a it gets a very little compensation for taking that that risk so that was one of the reasons why a AIG was one of the first one of the primary victims of the of the financial crisis now as I said there are no derivatives necessarily involved in to sales securitization because the actual death and the portfolio I've mentioned gets sold to the SPV but you can create you can create the same thing synthetically by instead of having a sale of that debt from the originator to the SPV you can have ACDs in there so that the originator keeps the debt but buys protection on it so the originator the bank lender the residential mortgage lender will get paid par if you know in relation to any defaults in the portfolio and of course then the losses will fall on the investors you know it distributed through the capital structure and the way I've just mentioned but in fact the debt does not actually shift from the originator to the SPD now so that's by greatly expanding you see well one thing in perhaps you can see one conclusion you can draw from this is that you don't you don't actually need you can write multiple synthetic securitization x' on the same on the same portfolio because you don't actually have to transfer anything so that's one way in which you can you can vastly expand the risk the other thing is that generally speaking in classic securitization there would be serious due diligence done on the underlined not sir that's always been true but at least you know the the the the custom was to do proper due diligence on the stuff that was being transferred into the SPV but with synthetic I don't know if there's something about the nature of synthetic risk or not but the the cut it became you know is it it just became the custom for there not to be serious due diligence done when perhaps we can explore why that might be so synthetic securitization the other thing so you also may have heard of terms like CDOs collateralized debt obligations but CDO is essentially a securitization of structured finance of the type I've just mentioned where the portfolio rather than being say student loans or corporate loans is our bonds of sometimes debt securities of some type although you also get collaborize loan obligations you collateralize bond obligations and so on you collateralized fund obligations all those are different types of CDOs and one of the types of debt obligations you can put into a CDO of course is another CDO so you have a CDO on a CDO that's called CDO squared and indeed you sometimes get CDOs on CDO squared so CDO cubed they again you can imagine if people are doing these slightly wacky things CDO cubed there's one layer after another between the ultimate investors and the actual risk that again seemed to create this false sense of security about you know that somehow this sort of the risk was sort of just running into the sands you know it's being dispersed by these this rather clever mechanism instead of running straight through to AIG but of course in fact what we saw was it was actually just a straight pipeline of toxin of financial toxin straight through to the end holder so now you know and in a sort of cartoonish sort of way that is a sort of overview of of how structured security securitization and structured financing were at the heart of the banking crisis and the sub hopefully got some sense and if you didn't hopefully maybe we can I can expand on it in the Q&A as to the the role that that c.d.s played in that but note there was no role of interest rate derivatives no significant role that I wear up no significant role of FX hedging there no suggestion that those somehow contributed to the haptic crisis just c.d.s and only c.d.s in the context of structured financing now more recently and more briefly we have credit default swaps being pointed out and and demonized in relation to the sovereign debt crisis and I there I mean you know many senior government officials including Angela Merkel and Nicolas Sarkozy and and others seeming to blame the default the credit default swap market at least in part this the specula so-called naked speculators driving sovereign borrowing costs up to the point where they could not be sustained as though there was no actual problem with you know underlying problem but just you know a group of reckless cutthroat slightly malevolent speculators and through them you know Joseph Stiglitz who I mentioned at the outset you know recently said in an article in The Guardian that he believed that the European Central Bank was to some extent adapting its policy or distorting the policy might otherwise have taken weaselly Greek debt to avoid credit protection on on the Greek debt being triggered just to protect banks who were protection sellers and is felt it should issue a refutation of that and you can and I can give references to those articles both pro and con if people interested in that but I think just to highlight some of these distresses to comments made by some Joseph Stiglitz um CD s are actually surprisingly transparent one of the regulatory solutions to to some of the criticisms of derivatives have been to require derivatives transactions to be reported to trade repositories and CdSe was one of the first classes of derivatives to be reported to trade repositories and Jamie's mihi regulators around the world have access to those trade repositories so they're actually transparent as to UM penis as to players and as to amounts of Bossier secondly the amounts involved are actually relatively small there's about 3.2 billion in exposure via CD s to creep sovereign debt compared to a couple hundred billion a Greek sovereign debt that needs to be restructured and that 3.2 billion is actually the aggregate for all players in the CD s market so the exposure of individual institutions is smaller and in fact that is that exposure itself of individual institutions would be marked to market I mean I discounted to market value and collateralized so further reducing the risk to the individual market participant and then you would even need to deduct from those figures the recovery value of the debt unless the Greek debt actually goes to zero in a subsequent default so the actual amount of risk are faced by participants in the CD s market is actually quite small so it is really unlikely that the ECB is significantly adapting its behavior out of some need or desire to protect a small number of CD s protection sellers at least that says disappear but it seems reasonable to me so the real causes of the sovereign debt crisis perhaps not naked speculation but over borrowing by sovereign governments based on unrealistic assumptions about growth perhaps reduced receipts due to the banking crisis and the general economic problems that followed that endemic corruption seems to be an issue in some countries that one name any specific countries but I suppose it's something that happens all over the world so now maybe just draw some quick conclusions before before hopefully we have a bit of a discussion I said that Buffett Warren Buffett talked about do it as being you know weapons of financial mass destruction and the weapon analogy is often often used in relation to derivatives and that puts me in mind of section 1 1 of the prevention of Crime Act 1953 which provides that a person without lawful authority a reasonable excuse is committing an offense if he has with him in a public place without lawful authority a reasonable excuse any offensive weapon and there are three categories of offensive weapon there's a weapon that's offensive per se such as a knife or a gun there is a weapon that's or that's there's an object that's adapted for use as a weapon such as a sharpened stick often those two categories are more or less you know the same or very close closely related there's a third category of an article carried by a person who intends to use it that is not normally used as a weapon but but the person who carries it intending to use it for the purpose of causing injury now I would argue that you know by analogy derivatives are certainly not offensive per se but by implication I suppose I'm suggesting that derivatives can be used for harm actually I don't really much like that weapon a metaphor they so on the metaphor I tend to use is that of a hammer a hammer can be used to build something or it can be used to kill someone and I think cameras are much more often used to to build things than to kill people but the key point is that it's a tool it has no derivative has no intrinsic moral quality and we haven't had time to discuss all the various good uses to which derivatives can be put but the huge volumes of derivatives that are done particularly interest rate and currency derivatives suggest that there is a serious economic utility to these transactions and ensuring efficiency efficient allocation of risk in the financial markets so needless to say my view is that at least one solution to the problems that derivatives raised from financial markets that should be off the table is banning derivatives entirely I think that solution should be off the table and that's not merely my view just a couple of weeks ago John Walsh who's the head of the u.s. office for the controller of the currency it's the current head anyway warned against overreaction and this is so this is one of the chief US banking regulators warned against overreaction and misperception surrounding the risks of derivatives which he feels could lead to harmful changes to a financial system that would actually be detrimental to market safety and soundness so I think there is the danger with party because people actually don't know what a derivative is really of overreaction and you know calling derivatives weapons of financial mass destruction you know raise emotion and I think don't help in that debate so I I've attempted to at least give you my practicing lawyers view of derivative the financial crisis I have deliberately not tried to talk about solutions but I thought we might talk a bit about solutions for the Q&A or how we how we get rid of the negative aspects of derivatives if we can or at least minimize them while preserving the positive aspects but we indeed open to questions or indeed talking about any other aspect of the financial crisis so that is really all I want to stay on the main topic

Channel: Cambridge Law Faculty

Views: 6,917

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Keywords: Corporate Law, corporate governance, Derivatives, Financial Instruments, Financial Law, Finance (Industry), Crisis, Economy

Id: dDHv5SA2EwY

Length: 43min 16sec (2596 seconds)

Published: Tue Apr 30 2013