But in derivatives, like nuclear mishaps, there are no small accidents. And now comes the bad news. The former describes the possibility that you've bet the wrong way. These losses are theoretically limitless, another interesting feature of derivatives. The latter risk is simply that the counterparty doesn't honor the agreement.
Credit risk is the problem that American banks are facing.
Buried deep within the arcane bank statements filed with the Securities and Exchange Commission is evidence of a potential chain reaction of derivatives heading toward an explosion. Analysts like myself are learning for the first time how derivatives behave in bad times. I think we've just seen the tip of the iceberg of the problems with derivatives. The banks say analysts such as Peabody are overplaying the danger, and, following some minor calamities in 1994, their use of derivatives follows a prudent management scheme. But according to the Treasury Department's calculations, the iceberg is huge.