Credit Derivatives in the Recent Global Financial Crisis

1671 Words Oct 15th, 2012 7 Pages
Credit Derivatives in the recent Global Financial Crisis
1.0 Introduction:
In the recent times credit derivatives have become a very popular financial security for investors. If we take a look at the chart given below we can see how the popularity of credit derivatives increased in the past decade. The maximum volume of derivatives was traded during the years 2005 to 2007 of which 2006 was the highest at $2000bn. Then when the financial crisis occurred at the end of 2007 the trading decreased rapidly the following two years to as low as $100bn in 2009. There has been claims from financial critics that these credit derivative are the main factor that has lead to the almost collapse of the world financial markets and if corrective measures
…show more content…
3.0 Why control measures are necessary?
From the simple description of what happened during the financial crisis as mentioned above, it is clear that the use or rather the overuse of credit derivatives was the major cause of the collapse of the financial market. The creatively designed derivatives helped to hedge the risks off parties involved and eventually the party held accountable for the risk would get lost in all the complexity of each tranche. In May 2010, the Financial Times quoted Warren Buffett with the following: “Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal to the financial system” (Lemer, 2010). This quote nicely reflects the fear of some market participants and observers that credit derivatives may threaten the stability of the financial system. The transactions of credit derivatives are not required to be disclosed by the market participants and this opaqueness in the system can easily lead to yet another collapse in the financial markets. Furthermore, there is no common method of documentation and thus control measures are only self-regulatory (Ayadi & Behr, 2009). Sometimes government heavily subsidizes the derivative markets making it easier for anyone to get credit derivatives cheaply. Almost one-third of OTC market trades require no margin or collateral requirements at all. Financial innovation has a bad reputation at the moment, because exotic derivatives were one of
Open Document