They were used heavily from the years leading up to the financial crisis. Investors bet big on bundled mortgage bonds of which eventually imploded, bringing down multiple major financial institutions in addition to causing the worst economic downturn since the Great Depression.
At their peak, total OTC derivative value hit just shy of $35 trillion from the second half of 2008, just months before Lehman Brothers collapsed, the seminal moment of the crisis, according to the BIS:
Growth of derivatives through the years:
Years earlier, Buffett had warned about the consequences of heavy derivative use, even though he has employed them himself at times.
“The derivatives genie is usually right now well out of the bottle, in addition to these instruments will almost certainly multiply in variety in addition to number until some event makes their toxicity clear,” the Berkshire Hathaway CEO warned in his 2002 annual report. “In my view, derivatives are financial weapons of mass destruction, carrying dangers of which, while right now latent, are potentially lethal.”
More recently, billionaire investor Carl Icahn also has warned of their danger, telling CNBC in Feburary of which exchange-traded products using leverage to amplify returns pose the latest challenge.
Derivative buildup began in 2000 in addition to rose more than 11 times higher than the $3 trillion or so value back at the turn of the century. While legitimately used to hedge some other investments, they exploded during the crisis as a way to play the subprime mortgage market. Collateralized debt obligations in particular were a well-known high-yielding vehicle of which helped account for the surge.
However, regulators have clamped down on bank risk, in addition to Wall Street institutions have reduced their exposure to the instruments.
Total notional value of the contracts also has fallen. of which total peaked at $710 trillion in 2013, yet has dropped to $532 trillion since.