UPDATE – WHAT LARRY SUMMERS FORESAW.

UPDATE – WHAT LARRY SUMMERS FORESAW. This is to boast that last year, on December 29, 2006, I posted on this article by Professor Larry Summers which discussed what might happen in 2007. Summers pointed out that commentators and the markets were saying very different things. Summers thought the markets were saying, “financial markets are pricing in an expectation of tranquillity as far as the eye can see.” He noted that the measures of volatility in the financial markets were very low; that is, the markets thought that, from a historical perspective, there was very little risk in financial investments. He then asked whether the financial markets were missing something. The following quote seems especially prescient: “As we observed in 1987 and again in 1998, some of the same innovations that contribute to risk spreading in normal times can become sources of instability following shocks to the system as large-scale liquidations take place. How dramatic increases in speculative capital and the use of credit derivatives and other hedging tools will affect the system’s response to the next large shock is a profoundly important but ultimately unanswerable question.” It turns out that there was still a lot of risk in the system, but it was so sliced and diced and hidden that it is going to take months and some bitter experience to find it all. Professor Summers has to be credited with remarkable foresight.