NEW YORK ( TheStreet) -- Warren Buffett once described derivatives as financial weapons of mass destruction. I have wondered over his disdain for these classes of "fiscal engineering." However, if arguably the world's greatest investor holds these complicated financial instruments in contempt, everyday common investors should be wary.
For most people, the term "financial engineering" means simply earning a check from a 40-hour week and investing part of it in successful stocks. But sometimes, through even basic investments, people become victims of fallout from these "weapons" indirectly, when they invest in companies exposed to high risk attributable to derivatives.
This topic came to the forefront last week when investors learned that JPMorgan (JPM - Get Report) suffered a $2 billion dollar loss in its synthetic credit portfolio since the end of the first quarter.
This announcement has forced investors to not only re-evaluate the state of our banking system, but from an investment perspective, it has also served to bring more scrutiny toward bank balance sheets in an effort to reassess risk and current valuations.
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