Enron and systemic risk

Regulators worry that concentrating derivatives market-making in a few major dealers poses severe systemic risk issues. Could one big player’s failure break the whole system? David Rowe says Enron is an ideal test case, with some encouraging indications

Stripped of the hype and fancy jargon, derivatives markets are a highly efficient mechanism for risk intermediation. This, and this alone, is the reason for their expansion and resiliency over the past 20 years.

If a company has a risk that management deems unacceptable they can hedge some or all of it with an appropriately structured derivatives contract. Thus, if an airline wants to protect against increased fuel costs it can enter a commodity swap where it pays fixed and receives floating