The dealers who financed the credit derivatives specs, along with the smarter investors in the trade, have been picking through the crash site debris and analysing the flight data recorder. They’ve been trying to decide what lessons this spring’s disaster in credit market speculation has for the future.

In one sense, of course, the lesson is always the same: what people learn from history is that they never learn from history. Young hedge fund operators were marched across the market minefields with correlation coefficients.

Unfortunately for perma-bears, goldbugs, and ghoulish journalists, this was not The Big One. The blow-up of the credit derivative correlation trade, and the subsequent unwinding of the speculators’ positions, is not going to lead to the next general market crash or economic depression. However, there are serious real world effects, and those could make the next market crash and economic decline more severe than it might have been.

Wall Street’s detractors compare it to Las Vegas, but that is quite inaccurate. In Las Vegas, they laugh up their sleeves at suckers, sorry, guests who have devised betting systems. Come on in, boys. On Wall Street there are thoughtful nods around the asset allocation committee when someone comes in with a new statistical model of securities prices.

It’s always the same model. We can be short the less risky asset, and long the more risky asset, and capture the spread between them. We can do this because we know how the prices of both assets behave under many conditions.

And they do know; except for just what would happen under the unforeseeable conditions that actually happened. This is the portfolio insurance trade of 1987, the interest only/ principal only trade of 1993 and 1994, the Bund/GKO trade of 1998, and so on. The mystery is what happened to the fresh-faced fools who explained each trade to me. Are they bartenders? Interior decorators?

So what did the banks and securities dealers learn? As one senior officer of a big dealing bank says: “If you look what happened, you see the acceleration in losses occurred because hedge funds and dealers were in the same trade. When the hedge funds got in trouble, they had to liquidate by selling to dealers who had the same positions. Under those circumstances, liquidity can dry up very rapidly. So when there is distress, and there is mark to market risk, that mark to market risk does not have a home.” A foster home, he means.

Why would this happen? Dealers are supposed to be the house of the trade; they are not supposed to have an opinion about the market’s direction, let alone act on it. When I worked for a gold dealer, it was said to be a firing offence to ask the boss’s opinion about what would happen to the gold price. We made nickel and dime profits, and never blew up.

But how do you keep staff, when by crossing over to the (hedge fund) customers’ desks they can make 10 times the money? So the management of the dealing banks allowed them to run proprietary trading books, whether they called them that or not, and gave them a taste of the action. Therefore, when things went wrong, they went wrong the same way for everyone at the same time. There was no one left to fade the action, as they might say on Fremont Street.

Why should the rest of us care? Well, the credit markets functioned better in the last mini-recession because the derivatives dealers and speculators maintained more liquidity and better price discovery than had been available in the past. While there were losses in the tough year of 2002, there wasn’t the shattering panic of earlier market declines. This probably made the recession shorter, and the recovery easier.

With the withdrawal of capital from the credit derivatives trade, there probably won’t be the same moderation of price declines, and investor rationality, in the next credit market downturn. Obviously we don’t yet know how big that effect will be.

Last week I had a chat with a friend who had traded credit derivatives for a hedge fund until the end of last year. Unlike his colleagues, he had seen the mispricings build up, and was short the market. Unfortunately, his firm could not accept the mark to market losses and he left to take some time off and regroup. In the past couple of months, of course, his positions would have made a fortune.

“You are 10 times the bad guy when you are losing money on a short position than on a long position,” he told me over coffee. “Not only are you losing money on your mark to market but you have a negative carry.”

So another lesson might be to give some more capital to contrarians.