We have learned, painfully, of the damage derivatives can do to an economy in a financial crisis. But derivatives are hurting the economy even on its best days, according to a new study.
In the crisis, derivatives exposures brought down giant financial institutions and markets, leading to the worst recession since the Great Depression. But derivatives are also weapons of slower, more insidious destruction: They drain cash away from productive segments of the economy into the financial sector, according to a new study by the progressive think tank Demos.
Derivatives can be opaque and confusing to even sophisticated investors, and the market for them is dominated by just a few of the biggest, savviest investors in the world. This combination allows banks to routinely overcharge their customers for the "innovation" of credit derivatives.
"Innovation has become a means to extract value from the markets," writes Demos fellow Wallace Turbeville, the paper's author and a former Goldman Sachs banker. This, he suggests, is sapping the economy's strength.
"Inefficiencies that transfer earnings to the financial sector are like a tax that redistributes wealth upward," he later adds. "This system cannot persist."
