Kass: Blinded by the Derivatives Boom

As a consequence of the broad-based financial and economic prosperity, another new paradigm emerged -- the notion that a long and uninterrupted economic boom was believed by many to lie ahead. That promise, abetted by the low cost of capital and interest rates, stimulated the straw that stirred the drink of growth and speculation -- namely, the financial derivatives markets.

That market mushroomed, in an unquestioning atmosphere in which T's were not crossed and I's were not dotted, to the point where the derivative market eclipsed the actual size of the markets it served. (In a generally unregulated market, this was an easy do.)

The appetite for derivative products creation grew almost boundlessly and was brought to us by that wonderful brokerage community that brought us the dot-com IPOs and biased research, stoking all asset classes and revving up the real estate market in particular.

Layers of different sorts of assets were securitized by the Street and packaged into one, and the generally unregulated asset-backed securities, collateralized debt obligations, special interest vehicles and so on were given their birth. The new securities gave way to their cousins; levered hedge fund pools of capital emerged to take advantage of the availability of borrowed money ("the carry trade") supporting those ABC and XYZ assets. They could, in theory, produce alpha (or excess returns).