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Wall St. now placing risky bets on the weather

by Alan Markow, published

This year’s light snowfall throughout the nation may enrich a number of Wall St. firms who essentially have bet against a good ski season. Hedge funds sell derivatives in which you can bet on the put or take side of snowfall amounts. Because most people based this year’s bet on last year’s snow-rich season, the Wall St. firms picked up the opposite bet (it’s just like shorting a stock, where you bet that the stock price will fall).

Now, with the season well along and relatively snow-free, the financial firms are looking like big winners.  One might expect the ski mountains themselves to use these derivatives to hedge against poor seasons. But Jeff Hodgson, who runs the Chicago Weather Brokerage and specializes in snow derivatives, says he has yet to work with a ski mountain.

It comes as a surprise (even a shock) to see this kind of betting on an unknown such as a full season’s weather under the guise of a Wall St. investment. And this really is wagering. As Stephen Gandel reported in the January 24th Time Business website:

“Typically, the way the contracts work is that the buyer and seller will settle on a number of inches of snow in a particular time period in a central area of a city. If accumulation is greater than that, the seller of the insurance has to pay out. But if the snowfall is less than the specified amount the contract will expire worthless.”

We might as well start calling poker chips “derivatives” and turn casinos over to Wall St. firms.

Here’s the deal: derivatives place wagers on the future price of an investment in an underlying market. They are secondary investments – not on the product or the company, but on the potential performance of that product or company. It’s well understood within the industry that derivatives are highly speculative forms of investments – and considered wagering by more conservative investors.

The scary part is the size and scope of the derivatives market. According to economist Gary Novak (as quoted in

"The total annual product of the globe is around $30 trillion. I estimate that the total value of the global real estate is around $50 trillion. A few years ago, Alan Greenspan said the amount of derivatives on the books was $200 trillion. More recently, the figure was stated to be $300 trillion. Now, someone is saying $770 trillion."

In other words, we are creating a house of cards called the derivatives market and hoping that it doesn’t all implode like the housing market did a few years ago.

There are a number of articles warning of such a collapse, most notably The Coming Disaster in the Derivatives Market by Michael J. Panzer, which quotes Warren Buffett as calling derivatives “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

It seems to me that this type of “investment” corrupts the entire financial market and erodes confidence in more sensible investment strategies. After all, if hedge funds offer the promise of a winning lottery ticket and call it an investment, why should anyone trust a supposedly regulated market?

James Wesley, Rawles, Editor of warns, “The early 21st Century may go down in history as the era of the Derivatives Implosion.”

We must be slow learners.

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