None of the pre-crash market certainties lasted

Financial wizardry over ‘Great Moderation’ came a cropper in the wake of the meltdown

In 2006, I sat with a New York banker who specialised in credit derivatives, who was explaining why the cost of credit had fallen dramatically.

It boiled down to “better modelling techniques”. We had become so good at forecasting risks like defaults or interest rate movements that bankers could drastically lower prices of loans and still make safe money.

“Have we actually gotten better at it,” I asked, “or do we just think we’ve gotten better?”

He gave me the patronising smile that math geeks reserve for those of us who stalled out in freshman calculus. “No, we’ve actually gotten better.”

Two years later, Lehman Brothers filed for bankruptcy. In the disastrous aftermath he, like many others, became an ex-banker. How cheerily simple the world looked when we sat on that sidewalk in the sun, and how brilliant and wise all the people in it seemed.

For I’ve been recalling, too, the long discussions I had with economists about a phenomenon that was then being called the “Great Moderation”.

Coined by James Stock and Mark Watson in 2002, the term was made famous in a 2004 speech by Ben S. Bernanke, then member of the Federal Reserve Board. It referred to a steady multi-decade decline in macroeconomic volatility — or, the economic cycles were no longer cycling so frenetically.

Most policymakers attributed this trend in large part to their own growing wisdom. Then, Lehman happened. Shortly after, I was interviewing a famous economist on the ensuing crisis. “A whole lot of graduate students have been writing dissertations on the Great Moderation. I wonder what happens to them all now?” he said. “If you haven’t changed your mind about a lot of things, you’re not thinking very hard,” he said.