David Swensen, of Yale Uni­ver­sity Endow­ment invest­ment man­age­ment fame dis­cusses the cur­rent state of the mar­ket and deriv­a­tives trad­ing. Swensen is cred­ited with the inven­tion of deriv­a­tives now com­monly referred to as "swaps."

Kim Clark from US News and World Report writes today:

The Wall Street trader who invented the swap says he's dis­mayed by how other traders have so abused his inven­tion and the "com­plete and utter fail­ure" of reg­u­la­tors to pre­vent the abuse that led to the cur­rent finan­cial meltdown.

David Swensen, now the leg­endary man­ager of Yale University's endow­ment funds, says swaps and other finan­cial deriv­a­tives ought to be traded on an exchange and hedge funds that get big enough to pose risks to the finan­cial sys­tem should be regulated.

"I don't think it is the tool that is the prob­lem," he says of swaps. "I think it is the fact that our reg­u­la­tory author­i­ties aren't doing their jobs" that allowed deriv­a­tive trad­ing to bal­loon dan­ger­ously. The burst­ing of that bal­loon is one of the main rea­sons for the Wall Street credit crunch.

In the late 1970s, David Swensen took his new Yale doc­tor­ate in eco­nom­ics to Wall Street. While work­ing for Salomon Bros. in the early 1980s, he fig­ured out a way for IBM and the World Bank to trade, or swap, pay­ments in dif­fer­ent cur­ren­cies. It was a key devel­op­ment in a larger Wall Street trend to cre­ate and trade new finan­cial "derivatives"–or instru­ments whose value is derived from an under­ly­ing asset or income stream. As a part of this trend, musi­cian David Bowie found investors will­ing to pay him upfront cash in return for the right to col­lect future earn­ings on his hit songs, for exam­ple. And an entire indus­try arose to cre­ate and trade deriv­a­tives based on the mort­gage pay­ments of homeowners.

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