Derivatives in this regard is a synthetic financial transaction of sorts. Either you pay $1 to buy $100 of risk or reward.... and/or you pay for something that will happen in the future, hoping it may or may not be worth $100 at that point in time.
Thusly, you can get yourself in a heap o' trouble...
Part of the problem is it's the "$1" value that goes on your books, and not the "$100" in terms of value at risk.. or notional value.
Good point. The crazy issue with the derivatives market is their was no central clearing house. How could that be??? (See Phil Gramm and the CRMA) We have clearing houses for practically every possible investment, including housing futures -based on the Case/Schiller index- (Now there was a good short). Derivatives were a GIGANTIC market, equal to 40 YEARS worth of USGDP at '08 values, which dwarfs both the bond and stock market by factors of 10.
There were a total of $532T worth of derivatives written going into '08, although the "net" exposure was purportedly only $2.7T, but when you have no idea who has underwritten whom, or what the collateral was, or how it was rated, it was a house of cards as soon as one largish entity defaults, because you no idea who & what they were cross-collateralizing; that is still the case for many of these contracts. I believe JP Morgan Chase currently has the largest book at $80T, which on a net basis may amount to $400M. AIG underwrote more of these contracts than anyone, which they likened to printing money when there were no defaults, and which is why the government "rescued" them, but Lehman Bros. to twist in the wind last fall. We are still feeling the effects of Lehman's BK. It will take several more years to unwind the AIG book. We are far from out of the woods.
What we need is a Federalization of the entire mortgage market as Sweden did in '91, after their own disastrous foray into deregulation of the mortgage markets in the late '80s. Their net cost was about 20% of GDP, in our case that would be about $2.6T, far less than the $8T "we" have pledged in TARP, TALF, etc. But we would all have to utter that word, which is anathema to some: socialization. It seems way cheaper to socialize, than to pay debt on upwards of $10T the way were are presently heading.