Jim,
Below is a very interesting article explaining a real example of the dangers of a very popular derivative: the Interest Swap. This is a derivative that many think (wrongly!) is safe.
‘Impossible to Understand’ Swap Burns 290-Person Italian Hamlet
By Alan Katz, Lorenzo Totaro and Elisa Martinuzzi
June 19 (Bloomberg) — Ortenzio Matteucci points to towns down the wooded Nerina valley in Italy’s Umbria region and blames peer pressure for his decision to let Polino, population 290, buy a U.S.-inspired financial swap he didn’t understand.
A retired steelworker with wavy gray hair, Polino’s Mayor Matteucci says he agreed to the interest-rate swap because Milan, with more than 1 million residents, and local towns Arrone and Stroncone all bought derivatives to try to save money. Polino’s contract has cost the village 6,579.66 euros ($9,200) more than it has earned since the town made the deal in 2005.
The long-term (can be up to 20 years!) contract is so disturbing to the cash flow of the Polino town that the mayor decided to break the contract and sue the bank which sold the product.
At this point, the interest swap not only became worthless to both parties, but became a big source of potential loss to both due to litigation.
Regards,
CIGA Christopher
