For those of you who don’t know I currently work full-time in the derivatives industry. Now to clarify I’m not a financial expert – I work in the investor education/marketing department. But I will say that working in this industry has its advantages, such as honing your bullshit detector when politicians and pundits start bringing out the pitchforks about derivatives and “greedy” bankers. Just to keep things in perspective, the only trading I do is with my 401k so I’m not an advisor, guru or know-it-all by any means.

But apparently James “Moufffffffff of the Soufffffff” Carville is. Or so he’d like us all to think. Mr. “It’s the Economy, Stupid!” is now excusing President Obama’s lack of communication luster on the financial crisis as not being the fault of his holy Messiah, but because the topic is too complicated. (via Financial Times) I usually have respect for things Carville says, but this I just have to shake my head in embarrassment.

The essential problem is not how good a communicator he is but the complexity of what he has to communicate. We can argue, ad nauseam, about which forum Mr Obama should use to level with the American people. Should it be on 60 Minutes or Jay Leno? Should he do fireside chats at the White House or predictions for the college sports season on ESPN? But that does not change what he has to communicate.

Now I’m not going to BS here. Derivatives are complicated to understand to the average person who’s never bothered to research them. But guess what – so is trading on ANY level – stocks, bonds, real estate. There are always going to be a few bad eggs or products, but that doesn’t mean the entire lot is then just as rotten. If you applied Carville’s reasoning excuse that would mean people should be afraid also of investing in their mortgage, investing in their 401ks, etc.

As someone who has prided himself on being able to reduce complex problems to simple messages, I am totally stumped by derivatives. After hours of research, they seem to be something rich, greedy bankers thought up to make more money selling them to other rich, greedy bankers. They did not understand what they were selling. Buyers did not understand what they were buying and insurers did not understand what they were insuring.

If Carville had bothered to shut his mouth and actually research derivatives for two seconds, I think he’d see that there is a way to communicate the complexity of derivatives in layman’s terms. The reason I know this is possible – because this is my job every freakin’ day. And I hear the feedback from people at the education events we put on to know that THERE IS a way to break it down in a simple form for ordinary people to understand. But you’ve got to give people a chance to understand, not just say “Uhhh, we’ve got the best economists around, people. Trust us!”

The problem is compounded by the fact that the only people who can explain them are the bankers who created them. It is like relying on a criminal to tell us how he committed a crime – and paying him to do it.

Last time I checked I’m not a banker and let’s see if even I can break it down. Trust me, there are hundreds of smarter men and women who could do a better job, but I’ll give it a try for my readers here. So, what’s a derivative?

Well, most of you probably know that you can buy stock of a company and that makes you a shareholder because you directly own a share(s) in that company. Whatever profit that company makes, you’ll be rewarded dividends based on how well the company did and your share of the reward is dependent on your percentage of investment in the company. If the company’s earning takes a loss, well, you’ll probably start resembling Yosemite Sam when Bugs Bunny got the best of him.

Now a derivative is a financial product whose value is determined in part from the value and characteristics of another security, usually referred to as the underlying security/asset.  The success or failure of a derivative is factored by the performance of the underlying security. The underlying also is a factor in the pricing of a derivative. Sometimes the underlying security is defined as stock. Sometimes it is defined as commodities like oil, corn, etc. Sometimes the underlying is an index. And sometimes the underlying security is a federal-guarantee of bundled mortgage securities from a government subsidy committing accounting fraud like Fannie Mae (Gooooooooooooo, Franklin Raines!)

These derivative industries are also typically heavily regulated and audited. In order to even trade them you have to read and sign off on a ton of disclosure and risk statements acknowledging you know both risks and benefits. So since the derivative is based on an underlying security it is directly impacted by the behavior of said underlying security. If the underlying security is built on accounting fraud and house of cards *cough*mortgage-backed securities*cough* then the derivative that is connected to it could be as well. There is more to it, but we’re talking out the basics here.

Further in his article, Carville does an injustice when he states that Obama can’t explain derivatives to the public because they are too complex, but then himself tries to explain terminology with an executionFAIL. Here’s an example:

To be fair, I thought Mr Obama did a good job on Jay Leno explaining the AIG situation until he used the word “leverage” (translation for laymen: financial shovel that people use to dig themselves into a deeper hole), a term that escapes 97 per cent of the public.

Sound the Alarm!!!

Gee, instead of trying to be fair, Carville, why don’t you try being accurate? Here’s the proper definition of leverage – When you leverage an investment, you use a small amount of money to control an investment that’s worth much more. Example, investors are using leverage when they purchase a derivative lower in cost than if they bought the underlying stock outright, and then profited from a change in the underlying stock’s price.  For a party that’s always bent out of shape on the myth of the wealth gap, it sure seems like you’re purposely missing the point on a strategy that allows smaller investors to make gains on the same level as the bigger investors, even though they have smaller capital to work with.

Now, I’m not saying derivatives are perfect, but they can be great tools for individual investors to minimize risk and maximize gains in the portfolios. And when I say individual investors I’m not talking about George Soros who’s probably benefited the most out of this crisis, thanks probably in part to Obama’s doom and gloom talk. (via PowerLine News)   Next time you hear one of these Pitchfork Dems complaining about derivatives and greedy Wall Street, keep in mind that Soros for YEARS ran a global marco fund where he traded GASP!!! derivatives on stocks, bonds and commodities. And Obama wouldn’t be where he is today without Soros’ help. But I digress.

Anyconspiracynut (LOL), I’m talking about the retired couple down the street or your relative that has a moderate portfolio on the side. Yes, there are people with multi-million dollar hedge funds that use derivatives but so do millions of smaller, individual investors. It’s not just about “greedy” bankers as Carville would have you falsely believe.

I hope this post provides at least a different perspective on derivatives for you. Realize that with any investment there is ALWAYS a learning curve – there are huge risks and benefits with any product. While my brief explanation is by no means the end of this topic, it’s at least a starting point. There is always going to be a debate about the contribution credit default swaps played in the financial crisis, as will there be discussions about mortgage-backed securities. But pundits like Carville should be more ethically responsible in presenting accuracy instead of blanketly throwing all derivatives under the bus. That’s not fair to the many, many decent, regulation-abiding traders out there and it’s doing a disservice to the inquiring public.

Yes, in the case of the credit default swaps the SEC missed the boat in a big way but that doesn’t give Carville a default pass to excuse Obama’s poor communication with taxpayers. Again, Obama wanted the job and sold people on the basis that he was the guy to get it done so the buck stops with him if he can’t explain it to his shareholders. If a company’s stock tanks due to poor performance, it’s the CEO’s job to explain to the angry shareholder’s the revised business strategy. Do you think shareholders would buy the excuse of “Well, in Mr. CEO’s defense it’s that our product is too complicated to explain.”???  Ummm – N-O. So neither should we as taxpayers accept this sad excuse for Obama’s poor communication. If the federal government wants to get into the business of buying up toxic assets then they do goooootz some essssplain’ to do to its revenue-providing taxpayers.