Do you believe in magic?
That’s what some folks are asking. Take Germany’s Angela Merkel: she has sharply criticized those who might profit from Greece’s distress. I assume she’s talking about hedge funds buying default insurance, driving up borrowing costs. Through the sorcery of derivatives, these dark wizards are brewing up a potion of fiscal pain.
Then there’s Gretchen Morgenson, the New York Times financial reporter, who breathlessly pointed out Sunday that cities and towns that lowered their expenses years ago through the charms of interest rate swaps were actually bewitched by a coven of advisers and brokers. Now they’re bound by unbreakable chains to the rock of negative cash flow. Unless they pay a break-fee.
Across the financial landscape, the white magic of financial innovation has morphed into the dark art of derivative alchemy. But nothing really has changed. Derivatives are a contractual tool for transferring risk from one party to another. Pretty boring, really. They weren’t a miracle when the economy was good. They’re not evil now that times are tough.
So when politicians or news folks try to convince you that finance is magic, there’s really only one response. Blow them off like so much pixie dust.
Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!
Follow me on Twitter @GlobalMarketUpd