"Many investment bankers - and some regulators and economists - argued in some sessions at last week's meeting in Davos that the growth of the $350,000 billion plus derivative sector has been beneficial, since it has helped reduce market volatility this decade and made the system more resilient to shocks by spreading credit risk.
"However, other officials fear that these instruments may now be raising leverage and risk-taking in the system to dangerous levels, and keeping the cost of borrowing at artificially low levels - thus increasing the chance of future financial crises."
Here at the Daily Reckoning we have our opinion; the more a financial innovation proves successful, the more successful investors will find ways to make it fatal.
Norman Angell’s book, published at the beginning of the 20th century, argued persuasively that new innovations in politics and markets of the period made war unthinkable. People stopped thinking about it. They stopped worrying. They stopped taking precautions. Never had people been more optimistic and more complacent than they were – right up until WWI began in August, 1914.
Then, all the innovations that so delighted Angell – industrialization, technological improvements, nationalization - became the exact same innovations that made it the bloodiest and most expensive war in history.
Coincidentally, that was also when US property prices reached their last epic high. In real terms, they went down in WWI and kept going down for 70 years or more. Only in the last 10 years have they gone back up – returning to their 1914 high only in 2005.
And now, a whole new round of innovations are supposed to make market crashes and depressions obsolete. Perhaps it is true. But we wouldn’t bet on it.
The credit bubble has now been expanding at an extraordinary rate for so long that people have begun to take it for granted.