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Explaining the financial crisis

The credit crunch was an accident waiting to happen, thanks to a long period of benign market conditions which encouraged riskier behaviour by financiers. But how did problems in the US mortgage market spread to become a crisis of bank capital?

By Charles Goodhart   February 2008

One of the striking things about the current financial crisis is the extent to which it was foreseen. Almost every major central bank, as well as the international financial institutions like the IMF, had been warning for some time about a serious underpricing of risk in the system. They pointed to low differentials between the financial returns paid on risky assets and safe assets and to increased levels of debt relative to underlying capital. In the face of very low interest rates, financial institutions were buying riskier assets to improve returns, often “leveraging” themselves several times over (by buying assets…

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