Banks Again Peddling Derivatives, as Investors Head for the Exit

(MoneyWatch)  Let's superimpose this picture...

Wall Street is marketing derivatives last seen before credit markets froze in 2007 as the record bond rally prompts investors to take more risks to boost returns.

Bank of America Corp. and Morgan Stanley are encouraging clients to buy swaps that pay higher yields for speculating on the extent of losses in corporate defaults.... Federal Reserve data show leverage, or borrowed money, is rising in capital markets.

...with this picture:

The stock-market declines last week... have reignited fears of another major correction in stock prices. Battle-hardened, weary investors are glued to trading monitors, ready to sell.

"Essentially, all measures of risk appetite are at the limit and one small step in the wrong direction now will lead to something more painful on the risk reduction side," the head of derivatives trading at a major bank told clients in an e-mail before the markets opened.

One image describes derivatives coming back into favor, leverage rising and risk checking out of rehab. The other shows the smart money running for cover. It's enough to make a fella crawl back under the covers (if only to cuddle with the dough stashed under his mattress).

Yes, it's a season for schizophrenia. The economy is healing, unless you happen to need a job. Bank profits surge, while credit shrinks. Wall Street does A) God's work; B) The Devil's work; C) Hardly any work at all. All or none of these voices in your head may be real.

Or maybe it makes perfect sense -- a cosmic reversion to the mean. Once, about 15 minutes ago, fear trumped greed. Now greed, properly securitized, collateralized and marketized, is making a comeback. Alternatively -- and here's a theory -- Wall Street often says one thing and does another (Henry Blodget, anyone?) You're shocked -- shocked -- I know.

Still. Even hardened vets of the financial wars must feel their jaw muscles slacken just a little at how quickly disorder is being restored. I understand that with bond yields contracting, investors will look for ways to goose returns. Derivative markets need risk, and vice versa. And clearly, since the markets are zero-sum, the smart money needs its dummies. I even accept that not all credit default swaps are created equal, with some more dangerously incomprehensible than others.

That's a problem. After the deluge, investors begin dipping their toes into "simpler" structured products. Until, maybe after a correction or two, returns level out and they paddle off toward deeper water. Glug.

The other problem is that most Wall Street analysts, credit analysts, economic analysts, media analysts and analysis analysts don't know what the hell they're talking about. If they did, you and I wouldn't be having this discussion.

Meanwhile, the banks whose financial "innovations" knee-capped the global economy -- the same ones blocking efforts to tame those innovations -- are back out there clanging the bell for derivatives. Come and get it!

Writes Bloomberg:

One obstacle to the return of riskier derivatives is the dearth of experts after financial institutions fired more than 340,000 employees, including mathematicians who created these instruments.

Let's parse that sentence for a sec to appreciate the situation's magnificent illogic. If financial institutions hadn't fired all those "experts" who created all those risky derivatives that turned into goo and made all the experts totally expendable, we'd have more experts to create more risky derivatives that will eventually turn into goo, leading to... I've lost track. Not Kansas, I bet.

The mind, reeling, looks for lessons in all this. A lifeline. One is that the smart money has an angle, which just may be pointed at your throat. Another is that lessons are for suckers.

Come and get it.