Termination of financial derivative market
At present this global financial crisis by the U.S. subprime mortgage crisis has triggered. By the product evolved into systemic financial crisis of the crisis, which exceeded market expectations, but also raises awareness of the nature of financial derivatives, financial derivatives market development and regulatory issues such as food for thought.
Financial derivatives in the financial crisis is indeed a hot topic. We believe that the tools have always been neutral, and financial derivatives as risk management tools, there is no fault of their own. Problem in two ways: First, the development of financial derivatives market over the real economy needs. For example, according to the end of 2007 prices, the United States only about 10 trillion for the mortgage, of which less than 2 trillion of sub-prime mortgage loans; while inferior race, credit-based mortgage-backed securities (MBS), collateralized debt obligations equity (CDO), credit default swaps (CDS) the size of more than 65 trillion U.S. dollars, far beyond the U.S. real economy needs. Second, financial institutions are not the use of financial derivatives to hedge risks, but to use its leverage to do investment, leverage magnification is so high that the event of a risk, it may lead to devastating blow. Sub-prime mortgage crisis, the United States Citigroup, JP Morgan Chase, Bank of America and other U.S. financial institutions, the average leverage ratio is about 35 times, which means that only one U.S. dollars of financial institutions can do 35 U.S. dollars capital investment, as long as the investment loss 3 %, investors will have more than one U.S. dollars in losses, equivalent to a total loss of principal. High-powered capital, leverage, making the risk of the outbreak of financial derivatives have a strong expansionary effect and huge losses, is this the U.S. sub-prime crisis evolved into one of the reasons the global financial crisis.
Here we need investment banks have a correct understanding of the nature. Investment bank based in his capacity as financial intermediaries exist, and its function is to provide consultancy services in order to overcome the information asymmetry between transactions. With the general difference is that consulting firms, investment banks not only provide consultancy services and can implement for clients. Due to the presence of investment banks, to a certain extent overcome the information asymmetry of both sides of transactions, thereby reducing transaction costs, investment banks from lower transaction costs in the extraction of part of compensation, which is an investment bank’s fee-based businesses. This in order to earn commission income-based business model, capital requirements are very low, implies the risk is very small, is the basis of investment banks to settle down.
After 70 years of the last century, the financial derivatives market began to develop. Financial institution, financial derivatives to hedge risk in addition, he also can take advantage of its leveraged investments. The higher the leverage to get the greater the ability of excess returns. In the temptation of high profits and fierce competition, under the pressure of a large number of investment banks began to engage in sub-prime market and the complexity of investment products, and quietly became a pursuit of high-risk hedge funds. U.S. real estate investment bank in the development of financial derivatives (particularly the development of secondary bond market), the creative role and a strong marketing capabilities to support and promote the growth of subprime mortgages. From the mortgage loan securitization, the U.S. investment bankers developed a series of dazzling derivative products, such as mortgage-backed securities, mortgage debt-equity, credit default swaps, synthetic CDO and so on. Of these complex derivative products far beyond the needs of the U.S. real economy, contrary to hedge financial derivatives trading and price discovery of the basic functions, just to meet a financial institution needs to make a profit with each other. In other words, excessive speculation and excessive leverage ratio makes the investment bank embarked on a road of no return.
The end of five major Wall Street investment bank, does not mean the end of the investment bank model, but patterns of hedge funds, investment bank to an end. Asymmetric information is always a need for someone to provide consultancy services, which is the investment bank’s traditional business.
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