The current financial crisis and derivative misuse

Abstract

The paper aims to discuss the role played by derivatives in the financial crisis and to identify whether it is these instruments or other factors that were behind it. Moreover, it looks at literature on control systems within the firms throughout the aforementioned event, to identify and bring to light any flaws and gaps. Moreover, it highlights opinions of persons involved, testimonies, papers and reports drawn-up, the lessons learnt and their mitigating factors, in order to enable address of the issues and avoid replay. The article suggests that many factors contributed to the quick deterioration in credit markets and large losses. Although, this has sometimes been attributed to one single main factor (i.e. the massive interlocking web of Over the Counter derivatives exposures), to take down the entire financial system would have taken more than just this. There are arguments both in favour and against this opinion, however the fact may be that a mixture of the exploitation of the New Financial Architecture self regulatory model by unethical traders, compounded by the fact that the financial structure allowed the financial institutions to set inflated prices on derivatives with unknown values, such as Credit Default Swaps could have been the culprit. Therefore, to avoid replay, there is need for transparency and accountability as proposed by the European Commission and also an external regulatory framework that stops unethical traders.