{"page":"\u003clink rel=\"stylesheet\" href=\"https://lessonplanet.com/assets/packs/css/resources-c03aa079.css\" /\u003e\n\u003clink rel=\"stylesheet\" href=\"https://lessonplanet.com/assets/packs/css/lp_boclips_stylesheets-af73c33d.css\" media=\"all\" /\u003e\n\u003cdiv data-title='Jan Kregel: The Continuing Risk of Derivatives' data-url='/boclips/videos/623c0dcb2c7ac8358578341c' data-video-url='/boclips/videos/623c0dcb2c7ac8358578341c' id='bo_player_modal'\u003e\n\u003cdiv class='boclips-resource-page modal-dialog panel-container'\u003e\n\u003cdiv class='react-notifications-root'\u003e\u003c/div\u003e\n\u003cdiv class='rp-header'\u003e\n\u003cdiv class='rp-type'\u003e\n\u003ci aria-hidden='true' class='fai fa-regular fa-circle-play'\u003e\u003c/i\u003e\nVideo\n\u003c/div\u003e\n\u003ch1 class='rp-title' id='video-title'\u003e\nJan Kregel: The Continuing Risk of Derivatives\n\u003c/h1\u003e\n\u003cdiv class='rp-actions'\u003e\n\u003cdiv class='mr-1'\u003e\n\u003ca class=\"btn btn-success\" data-posthog-event=\"Signup: LP Signup Activity\" data-posthog-location=\"body_link_boclips\" data-remote=\"true\" href=\"/subscription/new\"\u003e\u003cspan\u003e\u003cspan\u003eGet Free Access\u003c/span\u003e\u003cspan class=\"\"\u003e for 10 Days\u003c/span\u003e\u003cspan\u003e!\u003c/span\u003e\u003c/span\u003e\u003c/a\u003e\n\u003c/div\u003e\n\u003c/div\u003e\n\u003c/div\u003e\n\u003cdiv class='rp-body'\u003e\n\u003cdiv class='rp-info'\u003e\n\u003cdiv aria-label='Hide resource details' class='rp-hide-info' role='button' tabindex='0'\u003e\u0026times;\u003c/div\u003e\n\u003ci aria-label='Expand resource details' class='rp-expand-info fai fa-solid fa-up-right-and-down-left-from-center' role='button' tabindex='0'\u003e\u003c/i\u003e\n\u003ci aria-label='Compress resource details' class='rp-compress-info fai fa-solid fa-down-left-and-up-right-to-center' role='button' tabindex='0'\u003e\u003c/i\u003e\n\u003cdiv class='rp-rating'\u003e\n\u003cspan class='resource-pool'\u003e\n\u003cspan class='pool-label'\u003ePublisher:\u003c/span\u003e\n\u003cspan class='pool-name'\u003e\n\u003cspan class='text'\u003e\u003ca data-publisher-id=\"30357122\" href=\"/search?publisher_ids%5B%5D=30357122\"\u003eInstitute for New Economic Thinking\u003c/a\u003e\u003c/span\u003e\n\u003c/span\u003e\n\u003c/span\u003e\n\u003c/div\u003e\n\u003cdiv class='rp-description'\u003e\n\u003cspan class='short-description'\u003eEverybody now knows the narrative of the Great Financial Recession of 2008, in particular, the impact that toxic derivatives had in terms of exacerbating the crisis.  And the usual defense of those who misdiagnosed the crisis is that the...\u003c/span\u003e\n\u003cspan class='full-description hide'\u003eEverybody now knows the narrative of the Great Financial Recession of 2008, in particular, the impact that toxic derivatives had in terms of exacerbating the crisis.  And the usual defense of those who misdiagnosed the crisis is that the very nature of the so-called \"shadow banking system\" made it difficult to determine the systemic nature of the crisis and the corresponding extent of the banks' liabilities.  \u003cbr/\u003e\u003cbr/\u003eIn fact, that is a lame rationalization, as Jan Kregel notes in this interview. Kregel correctly points out that we've seen this show before in Asia during the financial crisis of 1997-98.  \u003cbr/\u003e\u003cbr/\u003eThe normal scenario for a developing country financial crisis would involve domestic firms borrowing in foreign currency from foreign banks at interest rates that are reset at a short rollover period.  Note that it makes little difference if the loans have a short or long maturity, the point is the change in interest costs on cash flows produced by the short reset interval for interest rates.  Short reset periods mean that a rise in foreign interest rates is quickly transformed into an increased cash flow commitment for the borrower, instantly reducing margins of safety.\u003cbr/\u003e\u003cbr/\u003eIf the change in international interest rate differentials leads to a depreciation of the domestic currency relative to the borrowed foreign currency, then the cushion of safety is further eroded by the increase in the domestic currency value of the cash commitments and the principal to be repaid at maturity. And finally, if the government responds to the weakness of the domestic currency in international markets by raising interest rates, then this clearly will make the situation even worse.\u003cbr/\u003e\u003cbr/\u003eAs Kregel points out, all of these conditions pertained in 1997-98, but what gave the crisis particularly formidable force was the used of customized over-the-counter (OTC) derivatives, most of which masked the nature of the true risks being undertaken by the borrower, as well as understating the extent of the credit exposures.  In many instances, these derivatives were structured in such a way as to avoid the national prudential regulatory guidelines in the country concerned.  In some instances, there was no market involved in these contracts, which may involve the stipulation of standard futures and options contracts outside the organized market on a bilateral basis with individual clients.\u003cbr/\u003e\u003cbr/\u003eHowever, the majority of OTC activity involves individually tailored, often highly complex, combinations of standard financial instruments, packaged together with derivative contracts designed to meet the particular needs of clients. These contract packages involve very little direct lending by banks to clients, and thus generate little net interest income. However, since they are often executed through special purpose vehicles (such as specialized investment firms that are independently capitalized), they have the advantage under the Basel capital adequacy rules of requiring little or no capital, or of being classified as off-balance-sheet items, because they do not represent a direct risk exposure for the bank. In addition, they generate substantial fee and commission income.\u003cbr/\u003e\u003cbr/\u003eRather than committing their own capital in these transactions, the banks serve as intermediaries whose services involve not only matching borrowers and lenders, but also acting as market innovators to create investment vehicles that attract lenders and borrowers. Nonetheless, these activities often require banks to accept some of the risks associated with the derivatives created in order to produce packages with the characteristics desired by final borrowers and lenders. But in many instances, the derivatives themselves are so complex and so inadequately \"stress-tested\" that their destructive effects can only be seen after the fact, which was clearly the case, both in 2008 and the earlier Asian financial crisis.\u003cbr/\u003e\u003cbr/\u003eThe other common feature that Kregel notes is that the major objective of active, global financial institutions no longer is the maximization of profits by seeking the lowest cost funds and channeling them to the highest risk-adjusted return. Rather, they are most interested in maximizing the amount of funds intermediated in order to maximize fees and commissions, thereby maximizing the rate of return on bank capital. This means a shift from continuous risk assessment and risk monitoring of funded investment projects that produce recurring flows of interest payments over time, to the identification of riskless \"trades\" that produce large, single payments with as much of the residual risk as possible carried by the purchasers of the package.\u003cbr/\u003e\u003cbr/\u003eThe upshot is that most derivative packages mask the actual risk involved in an investment and increase the difficulty in assessing the final return on funds provided.\u003cbr/\u003e\u003cbr/\u003eKregel discusses all of these factors in great detail in this video.\u003cbr/\u003e\u003c/span\u003e\n\u003c/div\u003e\n\u003cdiv class='action-container flex justify-between'\u003e\n\u003cbutton aria-expanded='false' aria-label='Read more description' class='rp-full-description' type='button'\u003e\n\u003ci class='fai fa-solid fa-align-left'\u003e\u003c/i\u003e\n\u003cspan id='read_more'\u003eRead More\u003c/span\u003e\n\u003c/button\u003e\n\u003cdiv class='rp-report'\u003e\n\u003c/div\u003e\n\u003c/div\u003e\n\u003cdiv aria-labelledby='resource-details-heading' class='rp-info-section'\u003e\n\u003ch2 class='title' id='resource-details-heading'\u003eResource Details\u003c/h2\u003e\n\u003cdiv class='rp-resource-details clearfix'\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eCurator Rating\u003c/dt\u003e\n\u003cdd\u003e\u003cspan class=\"star-rating\" aria-label=\"4.0 out of 5 stars\" role=\"img\"\u003e\u003ci class=\"fa-solid fa-star text-action\" aria-hidden=\"true\"\u003e\u003c/i\u003e\u003ci class=\"fa-solid fa-star text-action\" aria-hidden=\"true\"\u003e\u003c/i\u003e\u003ci class=\"fa-solid fa-star text-action\" aria-hidden=\"true\"\u003e\u003c/i\u003e\u003ci class=\"fa-solid fa-star text-action\" aria-hidden=\"true\"\u003e\u003c/i\u003e\u003ci class=\"fa-regular fa-star text-action\" aria-hidden=\"true\"\u003e\u003c/i\u003e\u003c/span\u003e\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt class=\"educator-rating-title\"\u003eEducator Rating\u003c/dt\u003e\u003cdd\u003e\u003cdiv class=\"educator-rating-details\" data-path=\"/educator_ratings/rrp_data?resourceable_id=206467\u0026amp;resourceable_type=Boclips%3A%3AVideoMetadata\"\u003e\u003cspan class=\"not-yet-rated\"\u003eNot yet Rated\u003c/span\u003e\u003c/div\u003e\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eMedia Length\u003c/dt\u003e\n\u003cdd\u003e14:15\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eGrade\u003c/dt\u003e\u003cdd title=\"Grade\"\u003eHigher Ed\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eSubjects\u003c/dt\u003e\u003cdd\u003e\u003cspan\u003e\u003ca href=\"/search?grade_ids%5B%5D=259\u0026amp;search_tab_id=1\u0026amp;subject_ids%5B%5D=358379\"\u003eSocial Studies \u0026amp; History\u003c/a\u003e\u003c/span\u003e\u003c/dd\u003e\u003cdd class=\"text-muted\"\u003e\u003ci class=\"fa-solid fa-lock mr5\"\u003e\u003c/i\u003e3 more...\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eMedia Type\u003c/dt\u003e\u003cdd\u003e\u003cspan\u003e\u003ca href=\"/search?grade_ids%5B%5D=259\u0026amp;search_tab_id=2\u0026amp;type_ids%5B%5D=4543647\"\u003eInstructional Videos\u003c/a\u003e\u003c/span\u003e\u003c/dd\u003e\n\u003c/dl\u003e\n\u003c/div\u003e\n\u003cdiv class='detail'\u003e\n\u003cdl\u003e\n\u003cdt\u003eSource:\u003c/dt\u003e\n\u003cdiv class='preview-source' data-animation='true' data-boundary='.rp-info' data-container='.rp-resource-details' data-html='false' data-title='At the Institute for New Economic Thinking we advance sound economic ideas to better serve humanity. 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