from Follow the Money

Social theory - and credit derivatives

April 17, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Last week, I heard a lecture by Hartmut Rosa, a social theorist who teaches, among other places, at the New School in New York.   

He thinks the defining feature of modernity - particularly what he calls late modernity (i.e. now) is acceleration.  Not only is the world changing, but the pace of change is speeding up.  And the fast pace of change creates demand for innovations that help us manage a faster world, which in turn end up only speeding the world up more (Crackberries?).  Or something like that.

The explosive growth of credit derivatives (see Table 1 of this chapter in the IMF's Global Financial Stability Report; hat tip, the New Economist) certainly fits with his thesis.   I remember a time (and I am not that old) when credit derivatives were rather exotic.    Now they seem to be the bread and butter of credit markets.   At least in certain parts of the financial world.   

CDOs  (collateralized debt obligations, packages of bonds) turned into synthetic CDOS (CDOs composed of credit derivatives).  Rather than trading credit risk folks started trading the correlation among the different companies (which became "names") in the CDO - since correlation is rather central to the performance of difference tranches of a CDO.   

If trading correlation among tranches of a synthetic CDO sounds kind of greek, that's the point.

Though for all I know, trading correlation among the credit derivatives that makes up a synthetic CDO.  may be a part of the past, not the future.  Maybe a derivative has come along that eliminates the need to actually own  (or short) various tranches of a synthetic CDO if you want to bet on the correlation among different names.  Or maybe the really sophisticated folks have moved on to something new.

If you want an easy to read introduction to this topic, I  recommend Mark Whitehouse's Wall Street Journal article.

And if you wonder whether all this (financial) technology really makes it safe to drive faster (financially speaking), you aren't entirely alone.   Far from it.   An awful lot has grown up in a period of relatively limited (macroeconomic) volatility.

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