Red-Blooded Risk: The Secret History of Wall Street

Derivative Money

Lehman's Treasury business was not entirely virtual. In addition to the cash accounts, there were other reasons some transactions needed real, physical settlement. The firm did maintain some real, physical inventory of bonds, although these were hedged by futures contracts. For the most part, however, the Lehman Treasury desk borrowed and lent specific things in the future. Virtual cash was used to keep the accounting straight, but real cash had only a minor role. That's one feature of derivative money. By the way, if you have a brokerage account and don't know whether it's a cash account or not, it probably isn't. That means the securities you think you own aren't there; they're lent out to other investors. The cash you think is yours is listed on the brokerage firm's balance sheet as if it were its cash. If you want physical possession of either your securities or your cash, the firm has to go out looking for them in order to get them to you.

The second feature of derivative money is obvious here as well. The only capital Lehman needed for this business was enough to cover the day-to-day price changes in its net positions. It did not need inventory or inventory financing. Okay, there are government rules mandating capital levels as well, and sometimes they are higher than the minimum required by the business itself. But these capital rules were switched to so-called risk-based capital in the 1990s, meaning that the capital requirement is based on how much net ...