NEW YORK – With the world economies generally booming and positive economic data coming in from around the globe, several participants at last week’s World Economic Forum in Davos turned their critical voice toward credit derivatives, hedge funds and “innovative structured financial instruments” – meaning structured products. (Financial Times:   http://www.ft.com/cms/s/4deef5e8-b007-11db-94ab-0000779e2340.html ).

The most vocal of critics was the president of European Central Bank, Jean-Claude Trichet, who “warned that rapid growth of structured financial products and derivatives make it increasingly difficult to weigh up risk in the financial system,”  wrote Gillian Tett in the January 29 Financial Times. According to Tett’s feature, Trichet claimed “investors needed to prepare for a ‘repricing’ of some assets because of potentially ‘unstable’ conditions.”

Innovation appeared to be Trichet’s chief concern. "There is now such creativity of new and very sophisticated financial instruments that we don't know fully where the risks are located. We are trying to understand what is going on but it is a big, big challenge."

Trichet’s doom-and-gloom sentiment toward the derivative market is familiar; such criticisms have been tossed around for the better part of a decade. And while it’s true that the notional value of derivatives globally is astoundingly large -- $450 trillion by some estimates – and the growth of structured products have contributed significantly to this number, the FT observed that others would counter that “the growth of the derivatives sector had helped reduce volatility in the markets and made the system more resilient by spreading credit risk.”

One of the most refreshing voices to counter the demonization of hedge funds, credit derivatives and structured products came from Bloomberg columnist Michael Lewis (also the author of “Liar’s Poker” and “Moneyball”). In his online column “Davos Is for Wimps, Ninnies, Pointless Skeptics” (click here for full text:
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_lewis&sid=aaagOLYMd4yg ), Lewis contends, “It's become almost obligatory for the world's most important economic people, at the beginning of each year, to travel joylessly to the base of a Swiss ski slope and worry. And to worry not privately, with dignity, but publicly, to anyone who will listen.” 

Lewis quoted several hand-wringing economists making statements such as “the system is becoming very complex. The risk of some crisis happening is rising” and “the world isn't pricing risk appropriately.”  Says Lewis, “Examine the public statements extruded by the World Economic Forum any year and you'll find the same warmed-over prudence . . . Davos is where people with no talent for risk-taking gather to imagine what actual risk-takers might do.”

“Derivatives seem to be this year's case in point . . . [yet] none of them seemed to understand that when you create a derivative you don't add to the sum total of risk in the financial world; you merely create a means for redistributing that risk. They have no evidence that financial risk is being redistributed in ways we should all worry about. They're just -- worried.”

SPA-2007.com thanks Matt Moran of CBOE for calling attention to the subject of this blog.

UPCOMING BLOGS: A top-level summary of the First Annual SPA-Greenwich Market Study, and some statistics on the growth of the structured products market in 2006 from the upcoming SPA press release.