September 1992 — The market for interest rate swaps, currency swaps, options and other complex financial derivatives had grown eightfold in just four years, to a notional value of $4 trillion, when the New York Federal Reserve Bank completed a survey in which bankers admitted that they did not fully understand these financial instruments. In “Derivatives: Just How Risky Are They?” Institutional Investor described the market as “a time bomb that could explode” and offered two scenarios that seem eerily prescient. The first predicted that “derivatives trading itself could cause a major bank to fail.” The second warned that “derivatives, simply because they now invisibly permeate the entire financial system, could turn an ordinarily containable situation — one that isn’t even caused by them — into a full-blown financial crisis.” The bomb did explode with the collapse of collateralized debt obligations and other mortgage-backed securities, ripping apart Wall Street and knocking out financial institutions across the U.S. and Europe.
