According to the latest semi-annual report issued by the Bank for International Settlements, the gross market value of outstanding over-the-counter derivatives is $25.4 trillion—yes, trillion—with 75 percent of the contracts linked to interest rates: forward rate agreements, swaps, options. In June 2008, shortly before the crash, the gross market value of outstanding OTC derivatives was $20.4 trillion, with 46 percent linked to interest rates.
So what has actually changed since the precrisis financial situation? Instead of tamping down speculative betting on interest rates in favor of rational market pricing of loanable funds, the Fed’s monetary policies are stimulating it. No wonder traditional financial intermediation—the kind that used to channel depositor funds toward promising new businesses—is now oriented toward gaming various hunches about the Fed’s next move. Even smaller banks are learning to churn their Treasury holdings rather than make loans to private-sector borrowers—especially since federal regulators are evaluating their portfolios.
Productive economic activity requires a commitment of resources based on faith in the future; it’s inherently risky, but that’s the nature and genius of capitalism. Unfortunately, the Fed’s tactics for suppressing interest rates have brought about conditions antithetical to entrepreneurial capitalism: loose money, tight credit.