Another devil in the financial crisis

By Jim Jubak

Bet you haven't seen this on a bumper sticker lately: "Save the derivatives market."

Hardly catchy. Especially since almost no one actually knows what a derivative is. And it sure goes against the emotions of the crowd right now.

Along with Christopher Cox, the head of the Securities and Exchange Commission and of a Wall Street culture of greed, derivatives are the villains in the current collapse of the global financial system.

But we'd better stop pointing fingers at these tools and start figuring out how to get this market functioning again if we're at all interested in ending the financial crisis before it drags all the economies of the world into a decade of stagnation with low growth and high interest rates.

This crisis is no longer about the U.S. housing market or mortgages, or even about failing Wall Street institutions. We're way beyond that. What's at stake now is the entire global financial system that has underpinned world economic growth over the past two decades or more.

If we don't fix that, the cost will be slower economic growth around the world, and especially in the U.S., over the next decade and perhaps longer. Here in the U.S., we'll be able to measure the cost in higher interest rates and a weaker currency, but the effects will be felt in every economy in the world.

Money in motion

What's broken is the financial conveyor belt that moved dollars around the world and made global economic growth go.

At the receiving end, this conveyor belt loaded up the dollars that the developed world, and especially the U.S., had paid to the oil economies of the Middle East, Russia, Nigeria and the rest of the gang, and to the global factory economies of China, India, Brazil and the rest of that group. It then delivered those dollars to the great financial recycling centers of New York and London, where they were turned into T-bills, mortgage-backed securities, Fannie Mae (FNM, news, msgs) debt and derivatives such as collateralized debt obligations and credit default swaps. The belt then returned its load of financial products back to the Middle East, Russia and China.

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The smooth operation of this conveyor belt meant that the dollars paid for oil and for manufactured goods didn't just sit in bank vaults in Beijing, Moscow and Riyadh, Saudi Arabia. Instead, they were recycled into houses built in Sacramento, Calif., engineering contracts in Osaka, Japan, and crane orders in Düsseldorf, Germany. That kept the economies of the developed world chugging along, which in turn kept up global demand for oil and other raw materials and for manufactured goods. That demand meant that China would have money to build roads and buy railroad cars, that Russia would be able to hire Schlumberger (SLB, news, msgs) to manage Siberian oil fields and that Saudi Arabia could build chemical plants.

It's no simple matter to recycle a cash flow that has amounted to $700 billion a year from the U.S. trade deficit alone.