Matt Levine: uncertainty

Transcript context

…I thought we would start with Matt Levine’s greatest hits. Then with Matt, having been a classics major, we’d move on to the Latin classics and maybe tie the two together a bit. Think about derivatives markets — you’ve worked in that sector. By some measures derivatives are over a quadrillion in value outstanding, but there’s another way you can measure the net positions and turn it into zero. So what’s the right way to think about how large derivatives markets are, and what’s the risk associated with that size? The right way to think about it, in the way that you would do it if you’re actually working in the derivatives market, is to think about the risk exposures of it. If you have an interest rate swap, the right way to think about it is the DV01, or the right way to think about an equity swap is the delta of it. Often, you see these quadrillion dollar numbers. They’re a quadrillion dollar notional of short-term interest rate swaps, where the idea that you could lose a quadrillion dollars on it [laughs] is quite low. The risk of that is quite low. The systemic question, I don’t know the answer to. How risky are derivatives in general is . . . There was a time when it was, “Derivatives are weapons of mass destruction.” Obviously, there’s a sense in which that came true, but I worked in equity derivatives, and total return swaps didn’t blow up the world. A specific set of exposures to specific risks were bad and were perhaps magnified by the ability to make zero-sum bets on them, but the idea that a notional of derivatives is somehow itself a risk factor was never super compelling to me. There’s a certain centralization of risk with derivatives, so you put a lot of risk into a clearinghouse. Maybe you can bail out the clearinghouse — if you have to — more efficiently than individual investors, but that also increases moral hazard. At the margin, do you think we’ve centralized derivatives risk too much or too little?…

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