But the most striking thing about the growing derivatives markets is the stability that has come with them. More than eight years ago, after Long-Term Capital Management blew up and lost a few billion dollars, the Federal Reserve had to be wheeled in to save capitalism as we know it.
Last year Amaranth Advisors blew up, lost more than LTCM, and the financial markets hardly batted an eyelash. ``The financial markets in 2007,'' some member of the global economic elite might have said but didn't, ``are astonishingly robust. They seem to be working out how to absorb and distribute risk more intelligently than any member of the global economic elite could on his own.'' Once the laughter subsided -- and someone took down his name to make sure he didn't make next year's guest list -- he might go on to point out that in spite of a great deal of political turmoil the markets have remained calm.
The Sarbanes-Oxley Act sticks a wrench in the American market for initial public offerings, and the capital-raising business simply removes itself to London and Hong Kong. Thailand installs capital controls and the markets force it to reverse its policy, virtually overnight -- again with nary a ripple. The Brazilian real is now less volatile than the Swiss franc; Botswana's debt is now more highly rated than Italy's. Oil prices double, the U.S. housing market tanks -- no matter what happens, financial markets adjust quickly and without hysteria.
This is a case in point of Daniel Davies's contention that while forecasting the future is great, forecasting the recent past is almost as good and much more likely to be successful. That is to say, it's not just enough to have the information, it's also important to draw consequences from it and react to them. This is why John Boyd held that the most important element of his Observation-Orientation-Decision-Action loop was the Orientation.
In this case, Lewis was well aware that a massive housing market bust was actually in progress, that the oil price was very high, and that a range of generally weird things had happened. But he didn't integrate this information into his broader situational awareness - he noted that nothing had exploded yet and reached for a variety of rationalisations, notably confirmation-bias, to explain why nothing would happen.
However, for his own part, he actually responded more effectively. He spent quite a lot of this article whining about people who weren't taking risks and wondering why nobody was going short if things were so bad. Well, in fact somebody was going short the US housing market. (Logically, somebody had to be short if so many people were so long - someone had to be taking the other end of those trades, as in fact he said in as many words.) And Michael Lewis later wrote a book about him, making a considerable profit.
Obviously, he was in a position to wait and see what happened, and then write the book either about the Great Bull Run of 2008 or the Great Crash. That helps. From a Boydian point of view, it is critical to all strategy that you keep your options open as far as possible and avoid being forced into reacting on the other side's time-table. It's also true, though, that the precondition of not being bankrupt in 2008 and therefore being able to take opportunities as they came was not taking risks in 2007, perhaps by doing a well-paying writing gig at Bloomberg in which you moan endlessly about people who aren't taking enough risks.
In fact, anyone looking for economic advice from Lewis in 2007 would have been well advised to ignore everything he said and instead study what he was actually doing.