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What's so dangerous about derivatives?" Institutional Investor asked back in September 1992. Quite a bit, as European Bureau Chief Kevin Muehring and Senior Writer Saul Hansell showed over the course of this cover story. 

It's a classic Institutional Investor story, breaking down a complex and opaque topic and delivering it to the reader in a digestible format. But few II stories — few stories by any media outlets — have quite the prescience of this one. (See the section on nightmare scenarios, for example.)

Hansell and Muehring had been covering the topic for several years and wanted to highlight the dangers and the need for sensible regulation. Indeed, Muehring was so keen to pick the brains of then New York Federal Reserve Bank president E. Gerald Corrigan, the loudest voice on derivatives at the time, that he refused to be turned off by repeatedly declined interview requests and chased Corrigan around the world, eventually catching up with him in Basel and again in London.     

This is the most recent in our ongoing series, From the Archive, which highlights the best of Institutional Investor's  financial journalism over the course of the last four decades. See also International Editor Tom Buerkle's 2002 story,  What's Wrong with the ECB


September 1992, Cover 
"I wasn't born yesterday," New York Federal Reserve Bank president E. Gerald Corrigan is fond of saying. His formative experience as a central banker was the Herstatt Bank crisis of 1974, when the collapse of an obscure German bank sent shock waves through the Euromarket. Since then Corrigan has dealt with the debris of the LDC crisis, the collapse of Continental Illinois Corp. and the depredations of Drexel Burnham Lambert. "I have seen them all," says the burly regulator in his gravelly voice.

So it was with a jaundiced eye that Corrigan began to probe the banks under his supervision about their headlong rush into the financial phenomenon of the decade: over-the-counter derivatives. Do you know the risks you are taking and how to control them? he asked. And as chairman of the Bank for International Settlements' banking supervisory committee, Corrigan was also seeking answers to the question looming ever larger in the minds of his fellow regulators in Basel: Could these new markets somehow destabilize the financial system?

The market for the highly technical, tailor-made instruments created through stand-alone or embedded interest rate and currency swaps, options and the complex combinations thereof, and known loosely as derivatives, has mushroomed eightfold in just five years. Its notional value is a whopping $4 trillion, according to the BIS, which works out to an estimated $250 billion in actual credit risk. For Corrigan, numbers like this in what has been a spottily regulated market -- one, moreover, that crisscrosses equity, fixed-income, foreign exchange and commodities markets -- are hard to ignore. Especially difficult to overlook is the fact that a mere dozen U.S. banks hold accumulated positions of $150 billion.