Risk addicts were seduced by derivatives

Our best and brightest have brought us to this brink.

It’s as if a financial Manhattan Project were hatched in the last decade, in which the brightest business minds in the world gathered in some dark dungeon filled with computers whirring with mathematical formulas for credit and risk assessment.

MY OPINION: THOMAS OLIVER
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Unlike the whiz kids on the West Coast, whose crazy ideas produce actual products — laptops, iPhones, or GPS for your car — our business brainiacs created a shadow banking industry played out on a Playstation.

It was understood by few. Unknown to most.

It was a game built around fear.

Lenders seek to minimize risk by taking out insurance against defaults.

This insurance is called many things: hedges, futures, options, credit default swaps. They are forms of derivatives, “financial securities whose value is derived from another ‘underlying’ financial security,” according to the Financial Pipeline. “Derivatives can be used for hedging, protecting against financial risk, or can be used to speculate on the movement of commodity or security prices, interest rates or the levels of financial indices.”

Insurance we can understand, even appreciate. But betting whether the insurance will be paid is akin to investing in whether your neighbor’s house burns. Normal people would think that’s sick.

What began as an aversion to risk ended up being an addiction to the thrill of risk.

Derivatives were concocted that were bets on the bets, whether the speculators were right or wrong. And there was a whole lot of hedging and betting on those bundles of risky mortgages.

The housing bubble burst over a year ago. But the financial markets didn’t freeze or the stock market crash until it was revealed that these default swaps exceeded the gross domestic product of the world — $60 trillion.

Richard Anthony, chairman and chief executive of Columbus-based regional bank Synovus Financial Corp., said, “The speculation and the betting on these swaps that created excessive speculation undermined our financial system.”

Anthony says we engaged in activity we couldn’t understand. That’s something our parents warned us against.

Doug Williams, president and chief executive of Atlanta-based Atlantic Capital Bank, spent his formative banking years at Wachovia, before it became “Second Union,” which led to its downfall. He was chief risk manager.

“The derivative market is at the nexus of the credit crunch,” he said. It represents “financial engineering at its worst.”

An attempt in the previous decade to regulate this “dark market” failed. Now, the SEC chairman is urging Congress to shine some light into the dungeon where our best and brightest mainlined risk.

Their addiction has become our Great Recession.

“We outsmarted ourselves,” Williams said.

Let’s hope more sober minds can lead us through the recovery process.