The Beginning of the End of the Credit Crisis?

by: Felix Salmon

David Gaffen is watching the VIX decline to levels well off its March highs, and back towards its lowest point of the year to date. Meanwhile, Alea is watching financial-institution credit default swap spreads decline to levels well off their March highs, and back towards the lowest point of the year to date. Could it be that we really are at the beginning of the end of the credit crisis? Has Ben Bernanke been successful in averting disaster?

"For the most part, investors appear to view the credit crisis as having passed over," says Gaffen - and this of course is one of the areas where investor sentiment has a tendency to become self-fulfilling. Of course, it helps that the Fed has turned the faucets wide open and is likely to keep them that way for the foreseeable future: if Ben wasn't dropping money from helicopters, things would surely be very different.

Still, if Nassim Taleb is to be believed, the time to worry is not when volatility is high, but rather when volatility is low.

Also, he says, people do not understand the link with the concept of volatility. In a market, if returns do not follow a "normal" bell curve distribution (as appears to be the case), volatility will actually be less than the bell curve would predict. For much more than the predicted two-thirds of the time, returns will be very close to the average. Such low volatility, counter-intuitively, is a danger sign that there is a greater risk of true "black swan" events, when returns do deviate from the norm, because it shows that returns do not follow a normal bell curve.
His geopolitical analogy is with Italy and Saudi Arabia. Italy has had many different governments since the war, while the same family has retained power in Saudi Arabia. This means that Italy is the more volatile but, he says, that Saudi Arabia is more risky, because if something does change in the political situation there, it will have much greater consequences.

On the other hand, if Saudi Arabia goes volatile and then settles down again, it's likely to be in a more sustainable place than it was originally. The people who mistrusted the Great Moderation were right. But if the world is really de-risking right now, rather than just mispricing risk, then this time around volatility might be falling for all the right reasons.