Dear me, he really doesn\’t understand, does he?

For example, there are some $554tn worth of so-called interest rate derivative contracts whose price is linked to Libor – manufactured products whose alleged purpose is to hedge the risk of unexpected interest rate changes in a world of floating exchange rates and free capital movements.

In fact, there is no way that these instruments can insure against system-wide movements. Some bank has to lose by being the sucker paying out, then becoming the weak link in the system which, in an extreme case, has to be bailed out by the taxpayer. Derivatives should rather be seen as economically purposeless constructs whose ease of manipulation in opaque markets makes the investment banks rich – while the rest of us take our chances.


Derivatives are indeed zero sum for the participants in the market. But as a whole they shift risk. That is their purpose and function. So is Ooour Woolly now saying that risk shifting is economically purposeless? Let\’s ban life insurance then, eh? Oh, and fire, house and flood insurance. And farmers should bear the risks of crop prices, bakers of input prices, no one should be allowed to offload that risk onto the speculators through the futures markets.

Because, you know, risk shifting is economically purposeless.


That is only a start. The banks and the British Bankers\’ Association can no longer be allowed to set Libor: this task must now be done by the Financial Conduct Authority that is to succeed the FSA.

Market interest rates are going to be set by the government, eh? No, no, I cannot see any form of moral hazard in that at all, Nope, not a scrap.

London must also fall into line with international practice and require all derivative trades in the over-the-counter market to post appropriate collateral.

Perhaps one of yuou more financially aware readers coud fill in here. I\’m aware of the way that with a CDS someone with an AAA rating did not have to post collateral (AIG being the poster chid for the subsequent problems) but I\’m unaware that anyone else in the markets, or anyone at all now, does not have to post collateral on a trade.

What is it that Willy has got mixed up here?

I would go further and require all financial instruments to be traded in organised exchanges.

Tee Hee. And what happens when someone wants a bespoke contract? Is an OTC contract to be illegal, meaning that one simply cannot transfer risks for something that is unusual?

And for the coup de grace:

As far as possible, the underlying causes of the over-inflated size of finance should be addressed. If there were less exchange and interest rate volatility, there would be less underlying demand for instruments to protect against it. This is, of course, the case for a system of managed exchange rates and a European single currency.

Instead of deifying floating exchange rates as the magic bullet for all economic ills – the default position of the British economic establishment across the political spectrum — floating rates should be seen as another driver of our over-inflated financial sector.

Join the euro and we won\’t need a financial sector!

A trivially small part of The City concerns itself with sterling, either in FX or interest rates. However, London is a place where much of the hedging across time of euro interest rates takes place. And $/€ FX as well. Neither of these woud be affected in the slightest is the UK was inside the eurozone.

I\’m sorry, but Hutton is one of two things here.

1) Deeply ignorant of the very system which he seeks to reform.

2) Lying through his teeth about how ignorant he is.

Either way, we really shouldn\’t be taking his prescriptions seriously.

7 thoughts on “More Willy”

  1. I spotted most of these errors in Hutton’s piece but just couldn’t be bothered commenting on them. The same mistakes and factual errors are trotted out week after week.

    Like the majority of commenters on financial markets from the Left it would be helpful if Hutton spent more time actually found out more about what he was critiquing.

    They complain enough that anti-climate change people aren’t climate professionals or have science degrees and yet feel quite happy to opine about finance without ever having traded a bond, passed a CFA exam or probably even switched on a Bloomberg screen.

  2. I’m fed up with people claiming that derivatives are useless. My MBA project, which I did with two people from the insurance industry, was on the usefulness of simple derivatives to manage interest rate and currency risk for retail borrowers – exactly what it seems the banks have been selling to SMEs. Yes, we never envisaged anyone in the retail sector using complex products – simple options and swaps are enough for most purposes. But to say that ALL derivatives are useless is simply wrong.

  3. To be fair, criticising Willie for not understanding derivatives is like having a go at a Mills & Boon author for lack of knowledge of reproductive biology. He doesn’t need to because his target audience don’t care.
    There are bad people in the City doing bad things. Willie’s told them so. The details aren’t relevant.

  4. Here’s my offering:

    Dear Ms Petropoulou

    Regularly, I read the Principal of Hertford College’s economic prescriptions in The Observer, and I am regularly astonished by his ignorance of economics, even though I am an amateur in the subject.

    Have you read his latest offering?

    See Tim Worstall here:

    Will Hutton demonstrates little understanding of Libor and derivatives, making statements that would apparently rule out many forms of insurance. Then, with the defects of the Euro plain for all to see, your Principal persists in promoting: “…the case for a system of managed exchange rates and a European single currency.”

    Do you think that your Principal’s journalism suggests to prospective students that Hertford College is a reputable place to study, particularly economics?

    I was a graduate student at Oxford. I will certainly ensure that my grandchildren do not apply to Hertford! I have no wish to silence a dissenting voice; but I fear Mr Hutton is bringing the University into disrepute.


  5. AIG lost its AAA rating in March 2005. The collateral calls that brought it down were triggered by the loss of its AA rating in September 2008. I don’t know the detail of the collateral triggers, but it seems that the collateral requirements on its CDS portfolio increased with each downgrade.

    The collateralization rules in OTC contracts are whatever the contracting parties agree: many OTCs are traded under the ISDA master agreement, which has an optional Credit Support Annex specifying collateral arrangements.

  6. On the collateral question he is talking total pish. Of course collateral is demanded when dealing with OTC derivatives in London. It would be madness not to – your clients are dealing on margin. Unless something has changed in the last 4 years even my then firms biggest clients who were well regarded hedgies had to post collateral. That was in FX options, can’t see why it would be any different on other desks. I can’t say who I worked for just that it rhymed with Organ Manly.

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