Debunking Derivatives Delirium

Abstract

Banks have gotten a lot of bad press lately. Some commentators have gone so far as to declare a banking breakdown, brought on by the free market policies of the 1990s. At the heart of much of the controversy is the explosive growth in banks' use of the sometimes complex financial instruments known as derivatives.

Close examination, however, suggests the potential costs of derivatives are often exaggerated and their benefits downplayed. Moreover, recent data provide evidence that despite talk of a breakdown, the banking system has been remarkably resilient. Contrary to popular claims, the free market policies instituted in the 1990s have contributed to, rather than detracted from, the industry's stability.

JEL Classification: G2, A2