Kass: Blinded by the Derivatives Boom

In summary, the momentum of asset-price appreciation and the rewards that were a byproduct of those gains have been intoxicating and virtually unquestioned, even as headwinds mounted, in a world in which the dominant investors (hedge fund managers) get a carried participation in their growth.

And so was the cocktail of derivatives, leverage and credit creation, which buoyed consumption in both the industrialized and emerging economies. What has recently intensified the problem is recognition that the derivative markets have bypassed the traditional conduit -- namely, the commercial banking system (governed by capital and reserve requirements and audits).

In the absence of oversight, accountability has been weakened and, at times, eliminated. And then, almost overnight, conduits worth tens of billions of dollars are revealed. And so are tens of billions of dollars of debt securities and loans the market is unable to value.

Surprise, surprise. It was especially a surprise to the money center banks, which are in the forefront of the dance of write-offs -- a marathon, not a two-minute fast step.

The problem with the aforementioned momentum and the overexuberance that follows is that it is does not last forever. Equally important (and often enigmatic) is that you never know what should end it -- nor what will end it.

Over the past several years, I have chronicled the seeds of what I believed would be the market's (self-) destruction -- in housing, in risk-taking and in the derivative markets. For a time, I am sure that many subscribers (and contributors) probably viewed my preoccupation with a housing downturn and the subprime problem with skepticism bordering on ridicule and even annoyance. I tried to demonstrate the logic of the developing contagion, but common sense was ignored.