Labour Economic Monitor (February 2008)

These are turbulent times in the economic world, and tumbling stock markets are just a symptom of a much greater malaise. The so-called “sub-prime mortgage crisis” (which actually has more to do with the proliferation of financial derivatives than with a few bad mortgages) remains a threat to financial institutions around the world, and no one knows exactly how large the problem is, or where the risks lie. Derivatives and similar financial instruments do two things very well: they transfer risk and they can create leverage, spinning large amounts of paper wealth based on a relatively modest foundation of real assets. When they are abused, and in a deregulated financial system they are bound to be abused, this means that instruments initially designed to reduce financial risk by allowing “hedging,” instead end up multiplying risk and generating economic volatility.