Derivatives dangers 101

Am almost done reading Fiasco. The author is a derivatives expert and formerly worked in the coveted Derivatives Products Group (DPG) at Morgan Stanley during the derivative heydays of the 1990's. The book is a true eye opener into the dangers inherent in the derivatives market. In a nutshell, derivatives are a black box which can camouflage the riskiest and most unstable investment and make it look like a AAA government guaranteed bond. Here are a couple of examples Partnoy talks about, regarding specific dirty derivative products that were shuffled by Morgan Stanley at the time.
1) A structured product that was created in such a way as to look like a safe investment. MS managed to get the AAA stamp on it (thus making it more attractive and marketable to investors) and hide the risky aspects of the instrument. It essentially was an investment who's safety was dependent on the horribly unstable Philippines national power company (NPC) that was poorly managed and in terrible financial condition. But the security was painted in a way to look like a safe, highly rated bond. Little did investors (many of whom were public entities such as state pension funds and small time insurance companies) know that they were essentially betting on the survival of a nearly bust corporation thousands of miles away in a developing country.
2) Another structured product Partnoy talks about was one which was marketed as a municipal investment in a US turnpike. Municipal bonds were considered safe investments. In reality, it was nothing of the sort. The instrument was actually a bet on interest rates in the UK.

Innocent and gullible investors who was sucked into the sales pitch of supposedly knowledgeable MS salespeople was holding severely risky investments disguised as safe products that would guarantee a return annually.

The derivatives problem has only magnified over the last couple of decades and notional value now exceeds a quadrillion dollars (far more than the smoke-and-mirrors estimate of the Bank of International Settlment of $500 trillion).

As Jim Sinclair says, the heart of the meltdown in 2008 was based on the derivatives dominoes imploding. The house of cards was saved by massive government intervention. But as the saying goes, what can go wrong will go wrong. So it is only a matter of time before this behemoth of derivatives comes crashing down and obliterating the Western financial system.