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October 2008

Forecasting winner of the year, maybe the decade

Carol J. Loomis, Fortune, March 7, 1994:

But transferring such a risk doesn't wipe it away. The risk simply gets passed by the initial contract to a dealer, who in turn may hedge it by a separate contract with still another dealer, who for his part may haul in yet another dealer or maybe a speculator who wants the risk. In the words of Rodgers and Hammerstein's King of Siam: ''et cetera, et cetera, et cetera.'' What results is a tightly wound market of many, many interconnections - global interconnections - that is altogether quite different from anything that has ever existed before.

Most chillingly, derivatives hold the possibility of systemic risk - the danger that these contracts might directly or indirectly cause some localized or particularized trouble in the financial markets to spread uncontrollably. An imaginable scenario is some deep crisis at a major dealer that would cause it to default on its contracts and be the instigator of a chain reaction bringing down other institutions and sending paroxysms of fear through a financial market that lives on the expectation of prompt payments. Inevitably, that would put deposit-insurance funds, and the taxpayers behind them, at risk.