The title of this submission is misleading. The quadrillion figure represents nearly ALL derivatives -- not just those deemed by someone to be frothy. About 1/3 of the figure encompasses interest rate derivatives. I haven't heard a lot of banter that the risk of rate fluctuation is mis-priced.
Also, what SHOULD the sum total of the value of the derivatives market be? The insurance I buy on my house is a derivative -- a contract whose value fluctuates wildly based on the performance of the underlying physical asset. Since almost all homes in the US are insured, the sum total of the insurance market is likely substantially more than GDP. What if there's a black swan event, like all of the US getting wiped out? Whatever will we do?
To further ease concern, many of these derivative contracts are likely offsetting. There will be winners and losers, but it's likely that there are just as many people protecting themselves from low interest rates as high interest rates, for example.
My favorite meaningless quote:
"...a lot of the problems of Enron in 2000 were brought on by leveraged derivatives and using derivatives to hide problems on the balance sheet."
Guns don't kill, people kill. Someone did something bad involving derivatives. So what?
I'm a bank. I gave a mortgage to a responsible homeowner who has bought a house that is within his means. Now that I've given this loan, a lot of my money is stuck and I can't give loans to other people. However, I know it's a good loan with a very low risk of default. So I turn and say "Hey, I've given this loan, and here are the details which explain how much this loan is worth in non-real terms. You'll have to guess at the market interest rate to figure out the "real" (economic term) "value", but that's doable. Would you like to buy it from me?"
If someone agrees to take possession of the loan, they'll have to reimburse the bank. Hey look! The bank has capital to repeat the process until it can't find any buyers of these loans. It's a good, honest bank, so it doesn't do anything fishy to move more loans. Eventually, we hit an equilibrium between people buying these loans, the bank holding loans, and people getting mortgages.
Now you're telling me a derivative, the thing the bank sold, has no value? Sir, I'm going to have to disagree.
Also, what SHOULD the sum total of the value of the derivatives market be? The insurance I buy on my house is a derivative -- a contract whose value fluctuates wildly based on the performance of the underlying physical asset. Since almost all homes in the US are insured, the sum total of the insurance market is likely substantially more than GDP. What if there's a black swan event, like all of the US getting wiped out? Whatever will we do?
To further ease concern, many of these derivative contracts are likely offsetting. There will be winners and losers, but it's likely that there are just as many people protecting themselves from low interest rates as high interest rates, for example.
My favorite meaningless quote:
"...a lot of the problems of Enron in 2000 were brought on by leveraged derivatives and using derivatives to hide problems on the balance sheet."
Guns don't kill, people kill. Someone did something bad involving derivatives. So what?