Derivatives

The worst thing of all is that buying an option has nothing to do with owning a share of a company. When a company grows and prospers, all the shareholders benefit, but options are a zero-sum game. For every dollar that's won in the market there's a dollar that's lost, and a tiny minority does all the winning.

When you buy a share of stock, even a very risky stock, you are contributing something to the growth of the country. That's what the stocks are for. [...] In the multibillion-dollar futures and options market, not a bit of money is put into constructive use. It doesn't finance anything, except the cars, planes and houses purchased by the brokers and the handful of winners. What we are witnessing here is a giant transfer payment from the unwary to the wary.

[... snip ...]

Warren Buffett thinks that stock futures and options ought to be outlawed, and I agree with him.

That's from the legendary mutual fund manager Peter Lynch in his 1989 classic, One Up On Wall Street.

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Among all the explanations of the current crisis, the one by Robert Feinman is possibly the best [thanks to Swarup for the link]. It describes in vivid terms the kind of crazy creatures that financial derivatives really are, and shows you that they just aren't investments at all!

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In 2003, Warren Buffett was as blunt as he was in 1989: he called financial derivatives "time bombs" and "financial weapons of mass destruction."

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In a short, but hard-hitting post, Dani Rodrik asks:

... What I would love to hear are some examples such financial innovation — not of any kind, but of the kind that has left a large enough footprint over some kind of economic outcomes we really care about. What are some of the ways in which financial innovation has made our lives measurably and unambiguously better?

If I had asked this question a little over a year ago, I suppose I would have been hearing a lot about how collateralized debt obligations and structured finance have allowed millions of people to purchase homes that they would not have been able to afford otherwise. Sorry, but you will have to come up with some other examples now.

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Two more links before I end:

1. Rahul's post on Markets and Honesty.

2. A gripping account a part of the on-going crisis [thanks to Lekhni for the link].