Way back in 1998, LTCM indulged in massive derivative trading and went belly-up.
As often, Warren Buffett got involved.
Wikipedia said:
On September 23, 1998, Goldman Sachs, AIG, and Berkshire Hathaway offered then to buy out the fund's partners for $250 million, to inject $3.75 billion and to operate LTCM within Goldman's own trading division. The offer of $250 million was stunningly low to LTCM's partners because at the start of the year their firm had been worth $4.7 billion. Warren Buffett gave Meriwether less than one hour to accept the deal; the time lapsed before a deal could be worked out.
The partners ended up with zero instead of the $250 million on offer.
LTCM employed two (2) winners of the Nobel Prize for Economics who guided their trading decisions! There were other adverse factors at work, but the Nobel-winning formula assumes the Central Limit Theorem, which applies to well-behaved signals. I don't think it takes a rocket scientist or a Nobel Prize to realize financial markets are not always well-behaved!!
LTCM was not exactly a big player, claiming only a few billion in assets. Compare this with BlackRock which manages $9.5 trillion today. (Yes, that's Trillion with a T. Admittedly, BlackRock does NOT indulge in the dare-devil gambling that LTCM did.)
Did Wall Street, or Congress learn a lesson from the LTCM collapse? No! "The system worked" as the big banks, whipped into line by the Fed, decided to rescue the financial system.
But the LTCM collapse was "small potatoes" compared with the 2008 crisis stemming from MBS derivatives, which plunged most of the world into the worst recession since 1933 (and it took luck, skill and cheating for it not to get even worse). And all for what? Most of the derivative trading served no public purpose: it was all so Wall St traders — some barely out of their teens — could trade their Ferraris in for Maseratis. When you consider all the Maseratis bought by those traders, and realize that trading is basically a zero-sum game, common sense should tell us that this use of brain power or financial power is NOT productive for society.
So surely after the turmoils of 2008, Wall Street and the government came to their senses, right? Even a tiny "Tobin tax" on financial transactions would eliminate the portion of derivatives trading which is just wanton gambling.
So in 2009 Congress obviously enacted such a Tobin tax, right? Even Congresscritters couldn't think repeating a financial crisis like 2008 every two decades or so would be a smart idea, right? The country learned its lesson. Right??
That source is 5 years old. I Googled; and it appears that most estimates of the total notional value (whether today or 5 years ago) are less than a quadrillion, perhaps much less. However it's hard to calculate some of the notional values and perhaps ambiguous what positions should be called "derivatives."
And "notional value" is misleading. For $1000 I can buy a put option that will be worth $1,000,000 if all 500 stocks in the S&P 500 go to zero, but that outcome is unlikely!
The total market value of all derivatives may be more meaningful. That number is "merely" in the tens of trillions, or just a small multiple of $100,000 per American household.
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