How Derivatives Made Your Mortgage Cheaper

NEW YORK (TheStreet) -- Consumers who are concerned about the impact of derivatives on their finances and the broader economy should consider the benefits over the past 30 years as well as the costs over the last two.

For example, derivatives have helped bring down the cost of mortgage borrowing significantly. Before interest rate swaps were widely adopted, the rate on a 30-year fixed mortgage was over 15%. For almost a decade now, they have remained under 10%.

That's partly because certain products, like interest-rate swaps, allow banks to offset the risk that rates will change dramatically, that people will repay early en masse via refinancing, or that people will stop paying their mortgages altogether -- all of which occurred in recent years.

Similarly, derivatives have helped mitigate the blow of big commodity-price swings on consumer products. Commodity futures are contracts that allow big companies that make food, fly planes or have a vast distribution network that relies on fuel to offset the risk that fuel prices will climb tremendously.

That's partly why during the oil scare in 1974, before derivatives existed, prices surged 11%. In 1979 and 1980, when another fuel crisis was followed by a recession -- and derivatives were still just a glimmer in Wall Street's eye -- prices spiked 11.3% and 13.5%.

But in 2008, when oil prices reached the highest level ever recorded and as the credit crisis was coming to a head, consumer prices rose a measly 3.8%. Inflation hasn't risen above 10% since 1981, when the first major derivatives transaction was structured -- not on Wall Street, but between IBM and the World Bank.

Of course it's silly to argue that mortgage rates and consumer prices owe their stability to derivatives entirely. But there's a definite correlation between derivatives and Main Street that can't be ignored -- unless you sit in the halls of Congress, of course.

The "D" word has received a lot of negative attention since the exotic variety helped to tear down American International Group and some investment banking counterparts. Lawmakers have fueled the hostility and represent a misunderstanding of how they are actually used. They've often used their pulpits to characterize derivatives as profit centers for banks on Wall Street that do little good for average Americans.

One of the most recent attacks came on April 27, when Goldman Sachs executives were grilled about a questionable derivatives deal structured in 2007. Sen. Claire McCaskill (D., Mo.) was particularly incensed, referring to a Goldman honcho as a "pit boss in Las Vegas" and criticizing the synthetic collateralized debt obligation involved in the trade.