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.

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4 Responses to UPDATE – WHAT LARRY SUMMERS FORESAW.

  1. Dick Weisfelder says:

    Remarkable foresight?

    There had been articles about the “housing bubble” long before Summers piece. Paul Krugman has been warning for years about a variety of risks in the system, such as unregulated hedge funds.

    Not to demean Summers or Schaefer, but the risks of huge US budget and trade deficits, the crisis of confidence in US foreign policy and rampant instability in oil producing states should have put up red flags long ago!

    It reminds me of the post-1968 pattern that I commented on last week.

  2. Philip says:

    I agree that there are a lot of risks out there, some of which haven’t hit yet. I thought that Summers identified a particular variety of risk, that financial instruments that markets thought were unusually safe, were in fact, risky.

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