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Anatomy of a disaster

Kevin Chinnery | Nov. 27, 2008
Who is to blame for the financial crisis?

Complacency then became recklessness. Trading derivatives for their own account had become hugely profitable for banks. In the case of US and European banks (although not Asian or Australian ones), they borrowed heavily to do so: going into debt to buy debt, using more debt as collateral. Welcome to the world of hyper-finance, where money made money out of money.

The rules also allowed banks to house securitised loans and other derivatives in off-balance-sheet "special investment vehicles" where they did not have to hold capital against them, vastly increasing the amount of debt instruments they could invest in without supervision. This created the so-called shadow banking system.

Until the music stopped, it was all highly profitable. Between 2000 and 2008, the issuing of credit derivatives rose 12-fold to $US3 trillion a year. Many banks raised gearing to 35 to 40 times to play this game - and between 2001 and 2007 they earnt a compound annual growth of 14 per cent compared with global economic growth of 4 per cent.


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