HOW MANY SAW THIS COULD HAPPEN AGAIN? Three years ago I was posting, for example, here, that a lot of the factors that had led to the financial crisis had been out in the open and almost nobody had noticed. I used a metaphor from bridge—that when there is a misplay from dummy which everybody at the table can see, it’s time to brew a pot of coffee. When I wrote that, I thought that some of the problems would not recur for a generation because everybody in the future would see what was happening and would apply the lessons of 2007 and 2008. Yet now, there is a high probability of the Euro breaking up in a financial crisis which would affect all of Europe. (The intrade market site gives a probability of 50% for Greece being in default by the end of 2011, which would mean the breakup of the euro.) And many of the problems that created the crisis in 2007 and 2008 are present again. The European banks have a lot of their assets tied up in very risky securities—sovereign debt issued by countries like Greece. Just as in 2007 and 2008, the Basel II standards treat very risky securities (in 2007-2008, Triple A toxic securities; now, securities issued by your own country) as completely safe. There is in fact a reward for holding these securities—a bank holding them can have a much higher debt multiple. And the banks do have extraordinary debt multiples (leverage). And, as in 2007-2008, there is extensive use of complicated securities which make it impossible to know how much exposure any other bamk may have so that a bank cannot know for sure how much credit risk it is facing when it does business with a counterparty. (Think of a bowling pin being knocked down by a pin that is hit by a third pin).

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