Will Derivatives Cause the Next Financial Crisis?

So predicts investing guru Mark Mobius

According to this Bloomberg report,

Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”

The total value of derivatives in the world exceeds total global gross domestic product by a factor of 10, said Mobius, who oversees more than $50 billion. With that volume of bets in different directions, volatility and equity market crises will occur, he said.

The global financial crisis three years ago was caused in part by the proliferation of derivative products tied to U.S. home loans that ceased performing, triggering hundreds of billions of dollars in writedowns and leading to the collapse of Lehman Brothers Holdings Inc. in September 2008. The MSCI AC World Index of developed and emerging market stocks tumbled 46 percent between Lehman’s downfall and the market bottom on March 9, 2009.

A financial crisis may be around the corner, but I highly doubt if derivatives will be the principal cause of it.

Derivatives were symptoms of the 2008 crisis rather than the cause. A bubble in the US housing prices had been pricked by rising interest rates which eventually got vented on the marketplace, part of which had been seen on derivatives.

Prescribing regulations, which for some function as an elixir, seems oversimplistic and naïve.

Regulators and the markets have played a perpetual cat and mouse game. Regulators usually apply regulations premised on the past events and markets usually find ways to circumvent them. Eventually fueled by monetary inflation, such loopholes become conduits for the next bubble. So regulations would look like the whack-a-mole game. Regulators hit the moles only as they appear.

And as pointed in the post below, regulations and complex relationships between politically privileged groups and regulators functioned as main causes to the last US mortgage crisis. History may rhyme but not necessarily repeat. Players and markets involved may be different, but principle will be the same. Bubble cycles from inflationism.

Besides, regulators are people too and so with market participants. While both may differ in their respective operating incentives, shared relationships and interactions will cause difficulties in the administration or implementation of regulations. Not even a total ban on derivatives will erase or reduce the risks of another financial crisis caused by inflationism. That would be barking on the wrong tree.