by Calculated Risk on 2/09/2007 12:55:00 AM

From the NY Times: Calm Before and During a Storm.

High on Mr. Geithner’s to-do list is understanding and monitoring the $26 trillion credit derivatives market ... the fastest-growing financial market there is. Its explosive growth has greased the wheels of the global economy, increasing liquidity, spreading risk and minting money for Wall Street along the way. But it has surged at a time when volatility has been low, debt has been historically cheap and defaults have been virtually absent. When this market gets tested, no one knows for certain how it may react.

Brad Setser worked for Geithner at both the IMF and the Treasury. Setser wrote last year: Things that keep the President of the New York Fed up at night. Setser quoted Geithner:

And when innovation, such as we are now seeing in credit derivatives, takes place in a period of generally favorable economic and financial conditions, we are necessarily left with more uncertainty about how exposures will evolve and markets will function in less favorable circumstances. The past several years of exceptionally rapid growth in credit derivatives and the larger role played by nonbank financial institutions, including hedge funds, has occurred in a context of very low realized credit losses, low expectations of future default risk, a high degree of confidence in the financial strength of the major banks and investment banks, relatively strong and significantly more stable economic growth, less concern about the level and volatility in future inflation, and low expected volatility in many asset prices. Even if a substantial part of these changes prove durable, we know less about how these markets will function in conditions of stress, and the most sophisticated tools available for measuring potential losses have less to offer than they will with the benefit of experience with adversity.

Reading the NY Times article it appears Geithner is diligently addressing these concerns.