The economic crisis didn't surprise Dr. Henry Kaufman; he just thought it would've come much sooner.

One of the country's leading economists and financial consultants, Kaufman recalls speaking at a conference sponsored by the Federal Reserve in Jackson Hole, Wyo., in 1984, when he warned folks about the growing sophistication and opacity of our financial system, which he felt demanded new supervision and regulations. He didn't find many people at the time were listening.

Having grown up right before World War II in Germany during the Depression, Kaufman, now 81, reminds us that people of his generation have always feared risk more than current business and public leaders do. Thus, they look differently at quantitative managers who believe they have derived foolproof methods for sidestepping economic meltdowns and at financial regulators who embrace the oxymoronic concept of "laissez-faire oversight."

Most worrisome to Kaufman has been the creation of mammoth financial conglomerates with huge balance sheets and thin capital bases that have magnified the debt problem with their heedless distribution of credit. These companies' balance sheet problems have now blurred analysts' measure of their solvency.

"Liquidity has come to mean your capacity to borrow," Kaufman says, "and that has led to an extraordinary change in business and household finance." The subsequent explosion of securitizations, credit derivatives and soaring leverage has created far less transparent, more vulnerable and less stable institutions.

These trends should have stoked fears, but Kaufman believes that our ability over the past half century to thwart crisis and stave off depressions has given us an unrealistic sense of confidence in deregulation and the relentless upward bias of markets.

He points to a series of economic failures in the 1990s: Southeast Asia's currency collapse, Russia's debt default and the economic turmoil across Latin America. "These crises were definable in geographic and financial terms," says Kaufman. Though these events involved hundreds of billions of dollars, they were relatively transparent and quantifiable. Because the world's major economies took only glancing hits, by and large many developed market companies, governments and investors were not crippled by these events.

Something Different
But today's crisis is systemic and embedded in the world's major financial centers of New York, London, Paris and Frankfurt. And its potential dimensions are very hard to measure because financial dysfunction has metastasized globally through the explosion of debt, derivatives and securitized obligations. "We can't accurately measure the scale of the problem," says Kaufman, "because underlying valuations are so uncertain, creating markets that are increasingly opaque."

Some observers may find comfort in the lessons learned from the Great Depression. But Kaufman warns that we shouldn't place too much solace in that experience. "Things were a lot less complex in the 1930s," he says. "Sure there were monetary and fiscal policy mistakes that made matters worse back then, and we aren't repeating the same missteps today. But remember at the time there were no financial derivatives, the dimensions of lending and investing were much more transparent, and domestic economies were more definable."

Kaufman is currently reading The Lords of Finance, Liaquat Ahamed's history of central bankers from London, Paris, Berlin and Washington, D.C., in the aftermath of World War I, which left the Western world in economic turmoil. Ahamed argues that the bankers' well-intentioned missteps, including the strong desire to maintain the gold standard, arguably contributed to the Great Depression by inadvertently restricting the policy response to collapsing economies.

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