If this headline caught your attention, I’m guessing you either know a lot about the risk associated with derivatives, or like me you think they’re too complicated to grasp, but you know they are the products worth trillions of dollars that played a role in nearly bringing down the global financial system in the great financial crisis of 2007/8.
I ran the police Fraud Squad at that time and wasn’t aware of the scale of fraud in the sub-prime residential mortgage market. In particular, how lending practices such as NINJA loans (No income, no job or assets) and the inaccurate credit ratings on the quality of those loans would have a catastrophic impact on Residential Mortgage Backed Securities (RMBS); these were the bad loans that were bundled together and sold to banks, pension funds and investors across the globe.
When investors got wind of the risk, the derivatives bubble burst and they were naturally very worried. Within hours, institutions stopped lending and individual customers were seen lining-up outside banks like Northern Rock in the United Kingdom, desperate to withdraw their life savings from institutions that held the securities. Governments stepped in with tax-payer led bailouts of various banks.
However, the popularity of derivatives has not faded according to the Bank of International Settlements. All investments carry fraud risk, however, I wanted to know what investigation and analysis an investor can do to spot warning signs in the derivatives market and minimize risk to themselves and their clients.
Surprisingly, few people talk about the derivatives risk but one person who is regularly quoted by Reuters, Bloomberg and others is my American friend, the veteran Wall Street analyst, David Hendler of Viola Risk Advisors in New York. David agreed to speak to me about Derivatives, what they are; why they’re so popular; why those who buy, sell and police them missed the danger signs that caused the near catastrophe in 2008. Most importantly, where he sees the big risks today and the warning signs that a derivative looks too good to be true or might involve fraud or money laundering. He even gave me his take on the Bank of England and US relationship after Brexit!
Please tune in to listen and I hope you find the information useful.