Derivatives and Leveraging

The upswing in market sentiment after the rescue of Bear Stearns may soon come to an end. Highly leveraged financial institutions, which use large amounts of borrowed money, may still face unexpected losses as the housing market and consumer confidence continue to fall. Institutions have taken more losses on underlying assets, causing them to be even more highly leveraged than before. As underlying assets fall in value, many derivative products will also be written down.

Derivatives, which allow financial institutions to derive what something will be worth in the future, are often overestimated in value by the people that issue them. Therefore, it is commonplace for institutions holding derivatives to be worth significantly less than they think.

Snapshot asks, what regulatory framework is appropriate for dealing with highly leveraged financial institutions holding derivatives?

Whitney Tilson - Dangers of Highly Leveraged Banks
Berkshire Hathaway 2002 Annual Report - Derivatives (pp 13-15)
Financial Times - Gloom set to worsen as threat of spiral grows
Financial Times - Securities firms' future
New York Times - It's Hard to Thaw a Frozen Market