Did Derivatives Cause the Crisis?

While I'm reading the front page of the NYT, it's worth noting the latest installment in its crisis series: 3,000 words from Peter Goodman on how Alan Greenspan's lax oversight of the derivatives market got us all into this mess to begin with. The nut graf comes quite a ways in:

Mr. Greenspan's legacy may ultimately rest on a more deeply embedded and much less scrutinized phenomenon: the spectacular boom and calamitous bust in derivatives trading.

Weirdly, Goodman never seems to find the space or time to actually demostrate that there has been a "calamitous bust in derivatives trading". I guess that's just taken for granted. This is the closest that the article gets:

As the housing crisis grew and mortgages went bad, derivatives actually magnified the downturn.
The Wall Street debacle that swallowed firms like Bear Stearns and Lehman Brothers, and imperiled the insurance giant American International Group, has been driven by the fact that they and their customers were linked to one another by derivatives.

But the fact is that Wall Street firms have always been "linked to one another" in one way or another. And it's not clear what derivatives Goodman has in mind here, but I suspect he's thinking about credit default swaps. But so far, the the CDS market has actually held up as the only efficient and liquid credit market out there; I'm far from convinced that its absence would actually have helped matters.

It's true that CDS were the instruments that brought down AIG and the monolines, and it's also true that Wall Street banks had to scramble to write down debt instruments they held on their books which were guaranteed by the likes of MBIA and Ambac.

But ultimately the biggest problem in this crisis was not the derivatives, but rather the fact that the banks held all those mortgage-backed assets on their books in the first place. They always claimed to be in the moving business, not the storage business -- but somehow they ended up storing an enormous quantity of debt which turned out to be highly toxic.

Yes, derivatives played a walk-on part in that story: banks felt comfortable hedging their positions in the CDS market rather than selling those positions outright. And more generally, the existence of the CDS market helped banks get altogether too comfortable with the amount of leverage they were taking on. But to date I haven't seen the "calamitous bust in derivatives trading" that Goodman talks about. Although it might come tomorrow, with the Lehman CDS auction.