When Bear Stearns announced last month that two of its financial vehicles had lost a lot of money as a result of some misplaced bets on the fragile American housing market, the news seemed ominous.

Housing has been the dog that hasn’t barked for the US economy in the past year. Or perhaps it would be more accurate to say that it has barked a fair bit and even chased one or two caravans down a couple of empty and overpriced streets, but it hasn’t really sunk its teeth into the shins of the American consumer, as was widely expected.

A year ago it was almost axiomatic (at least among the gleefully gloomy community of financial commentators) that the great US housing bubble was set to burst, with consequences of untold magnitude for the American and perhaps the global economy. If US residential prices declined significantly from their excessive levels of the past few years, they would surely produce a sharp contraction in consumer wealth and spending and tip the American economy into its first recession since 2001.

But it hasn’t quite worked out like that. True, weakness in the residential construction sector has subtracted something like a full percentage point from US economic growth in the past year, but this is hardly the Armageddon that was predicted. New research suggests that consumers did not seem to have spent as much of their increased wealth during the fat years as was previously thought, so when lean times rolled around, the negative effect was also much smaller.

But if the broader macroeconomic consequences of weak housing have failed to show up as expected, perhaps it is still possible that the narrower financial consequences will do the trick.

Here, attention has been focused on the market that has produced the most notorious financial neologism since Enron accounting: sub-prime lending.

Evidence of distress in the sub-prime sector – riskier loans, such as those to individuals with weaker credit histories or those based on high income multiple or loan-to-value ratios – was rife earlier this year. The financial pages were full of fabulous tales of mortgages of a design so exotic that they bordered on the rococo – 110 per cent loans advanced on the assumption that house prices would continue to rise at 20 per cent per year; no documentation “liar loans” that enabled some highly dubious individuals to borrow millions.

As house prices drifted down, these excesses were surely going to cause serious financial dislocation, with devastating consequences for some institutions and for financial markets more broadly. But again, so far, these widely expected shocks have not materialised. Why not?

Lost in so much of the handwringing hype and chronicles of collapse foretold about US markets in the past year has been the simple fact that in the past 20 years we have seen one of the most important financial revolutions in the history of capitalism.

The diversification of risk that was stimulated by financial deregulation in the 1980s has helped to shield markets from the broader consequences of financial dislocation. In the past, when economic conditions deteriorated, financial institutions that had lent money to borrowers bore the brunt of the risk. When their loans could not be repaid, these banks got into deep trouble, transmitting financial instability throughout the system.

Yet in the past 20 years, sophisticated financial instruments – securitised loans, derivatives based on the value of the underlying assets – have enabled markets to repackage and sell the original loans to investors around the world, spreading the risk so thinly that a downturn in one market does not result in financial collapse near by.

In effect, what these changes have done is to transform the famous old saying about lenders and borrowers. We used to say that if you owe the bank a thousand dollars, you’ve got a problem; if you owe the bank a million dollars, the bank has a problem. Now the probability is that if you owe the bank a million dollars it means you actually owe a thousand dollars to a thousand investors around the globe. If you default, you don’t bring your bank down with you. It merely means pension funds and insurance companies are a little bit worse off than they were.

But what about the Bear Stearns problem, you may ask. Doesn’t it suggest that systemic problems can still build from contagion, even in the revolutionary new financial markets?

Bear’s problem, in fact, seemed to have stemmed not directly from overexposure to a risky market, but from poor information about the quality of some of the assets in that market.

Put crudely, some of the securitised packages of sub-prime loans bought by Bear Stearns’ subsidiaries and other hedge funds had absurdly high credit ratings. The ratings agencies responsible for determining how risky an asset class looks seem to have underrated the degree of risk in some of the sub-prime market.

If you put a lot of dodgy-looking loans together in a package, simple probability theory suggests that you should get a lower total risk of default than you would have with just a single loan.

But it ought still to look much riskier than buying the debt of a large blue-chip American company. Yet somehow those were the kind of ratings assigned to some of these sub-prime instruments.

Financial markets are much more liquid, much more flexible and much more sophisticated than they were 25 years ago.

That transformation has significantly reduced the risks of financial contagion from a crisis in one sector. But those markets still need accurate and timely information to function effectively.

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