“Derivatives are a huge, complex issue." - Judd Gregg

When you hear most people talk about the causes behind the Great Recession and the 2008 financial crisis, many people place the blame on derivatives. But when asked what exactly a derivative is, we're met with stutters and stammers. In a few words, a derivative is a bet on a bet.

“We've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous. ...So we use lots of things daily that are dangerous, but we generally pay some attention to how they're used. We tell the cars how fast they can go." - Warren Buffett

Derivative: something that is based on another source.

In the world of finance, it's a contract that derives it's value not from itself but based on the performance of an underlying asset. The price of the security is based from one, or a group of underlying assets, such as stocks, bonds, commodities, currencies, interest rates, and even market indices. The derivative itself is nothing more than a contract between two parties, with the value being determined by the fluctuations in value of its underlying asset or asset group. Legend has it that the original derivative contract was between Aristotle and Thales over an olive transaction, and Aristotle wound up on the profitable end of the deal.

One of the most attractive aspects of derivatives is the flexibility in their structuring.

Because the contract does not involve the purchase or holding of an actual asset, terms can be completely modified as the parties see fit. You simultaneously relieve yourself of ownership of an actual asset, while still being able to play in the market. There are a plethora of types of derivatives for all suits and purposes. In some cases, derivatives can be used to speculate the price of an asset, hedge against risk on an asset, or circumvent issues with exchange rates.

“What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so." - Alan Greenspan

The majority of derivatives on the market are traded OTC - or Over The Counter.

These are unregulated, and typically present a greater risk to the counter party than do standardized derivatives. Standardized derivatives are regulated and traded on an exchange.

Derivative trading with mark-to-market accounting degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade." - Charlie Munger

There are however, certain risks and criticisms attached to derivatives. Too much hidden tail risk, and in a phenomena known as "phase lock in," your hedged position can become un-hedged at the worst moment- overnight. The double edged sword in the attractiveness of derivatives lies in leverage. Because of leverage an investor can use derivatives to turn a small amount of money into large returns rather quickly. However, just as quickly, one can suffer losses far greater than one's initial deposit, often greater than one can repay.

An impressive collective $39.5 billion was lost in the past decade by banks such as AIG.

"Derivatives are financial weapons of mass destruction." - Warren Buffett

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What do you do when financial hardship hits and you can't make your monthly mortgage payments? This is a question on many homeowner's minds as nearly 17.8 million Americans are reportedly unemployed during the coronavirus pandemic.

When homeowners face financial hardship, such as the loss of a job, they often look to obtain a forbearance agreement from their lender. A forbearance happens when your lender grants you a temporary pause or reduction in monthly payments on your mortgage. Forbearance is not the same as payment forgiveness, in that you still have to pay the entire amount back by an agreed-upon time.

Mortgage lending institutions differ on their mortgage relief policies and qualifications; however, the Coronavirus Aid, Relief, and Economic Security (CARES) Act were signed into law in late March of this year to protect government-backed mortgages.

Federally backed mortgages include:

  • Fannie Mae
  • Freddie Mac
  • The Federal Housing Administration (FHA)
  • The US Department of Veteran Affairs (VA)
  • The US Department of Agriculture (USDA)

Under the CARES Act, homeowners with a federally backed loan who either directly or indirectly suffer financial hardship due to coronavirus automatically qualify for mortgage forbearance.

Even if your mortgage is not secured by one of these agencies, you still can call and see if you qualify, as many lenders will still offer the option in order to avoid foreclosures.

Under the CARES act, homeowners can claim mortgage forbearance due to financial hardship from COVID-19 for up to 12 months without requiring any documentation or verification. During the forbearance period, mortgage lenders cannot charge late fees or penalties.

Additionally, as long as your mortgage is current at the time you claim forbearance, the lender is required to keep reporting your mortgage as paid current throughout the entire period.

At the end of the forbearance, the CARES act protects consumers from having to make a lump sum payment. Instead, you will be given a repayment plan from your provider. Since repayment options vary, it's important you ask your provider about all of your repayment options.

Possible Repayment Options:

You may be eligible for a loan modification at the end of your forbearance. With modification, the mortgage terms are changed in order to add payments that were missed during the forbearance onto the end of the loan, extending the term.

Another option that may work for some is a reduced payment option. This allows you to keep paying monthly payments at a reduced amount. The amount missed is usually added back into the monthly payments at the end of the forbearance.

For example:

Regular payment: $1000 per month

Reduced payment: $500 per month

Payment after forbearance period: $1500 (until caught up)

Balloon payments, or lump sum payments at the end of the forbearance, are prohibited under the CARES Act. However, mortgage lenders may require homeowners who are not protected under the CARES Act to make a balloon payment at the end, so again it is best to check first with your provider.

Mortgage forbearance should only be considered in true financial hardship. In other words, just because of the pandemic, you should not take a forbearance on your mortgage if you can still afford your payments. Likewise, if you are able to start making payments before the forbearance period is up, it's best to do so as soon as possible.

The Next Steps:

Before you get in touch with your mortgage servicer, save time by gathering as much documentation about the mortgage as you can. Also, be ready to list your income and monthly expenses. Due to an influx in calls, financial institutions are experiencing extremely long wait times right now, and having your information at the ready will help.

Have questions ready to ask. Here are some questions you should be asking:

  • What fees are associated with the forbearance?
  • What are all the repayment options available to you at the end of the forbearance?
  • Will you be charged interest during the forbearance period?

If your forbearance is approved, make sure to keep all documentation pertaining to it. Make sure to cancel any automatic payments to the mortgage during the forbearance period, and keep tabs on your credit report to make sure your lender doesn't report the loan as unpaid.


For more information on forbearance, contact your lender and discuss your options. If you need more assistance with understanding your options, you can contact a local agent for the housing counseling agency, or call their hotline at 1-800-569-4287.