The end of alchemy6/7/2023 There was an inability to see through the veil of modern finance to the fact that the balance sheets of too many banks were an accident waiting to happen, with levels of leverage on a scale that could not resist even the slightest tremor to confidence about the uncertain value of bank assets. The failure before the crisis was a lapse into hubris – we came to believe that crises created by maturity and risk transformation on a massive scale were problems that no longer applied to modern banking, that they belonged to an era in which people wore top hats. But it quickly became clear that it was in fact a crisis of solvency, and that a solution would require the combined efforts of central banks and taxpayers. In September 2007, the consensus was that the crisis was solely one of liquidity. And the distinction between liquidity and solvency is one that may be observable only after a detailed examination of a bank’s balance sheet, difficult for the authorities and impossible for investors. Banks will always claim that their problems result solely from illiquidity rather than a fall in the value of their assets. In only a matter of days, a shortage of liquidity can turn into a solvency question. But it is never easy to distinguish between a liquidity and a solvency problem. “Flooding the system with liquidity has been seen by many economists, officials and politicians as the answer to almost any financial crisis.
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