Due to the lack of transparency, no one knew the exact extent of banks’ exposure to securitised mortgage loans. Consequently, market participants began to mistrust one another. At the same time, many banks found it difficult to assess their own exposure, and they began to prepare for the worst. Princeton University’s Markus Brunnermeier called this “a textbook example of precautionary hoarding by individual banks”.
As a result, money market liquidity dried up fast. Banks were no longer able to tap into the interbank market to secure their funding. And such a squeeze of liquidity can even break a solvent bank’s neck – especially when it is engaged in maturity transformation and is short on liquid assets. At the same time, prices of financial assets began to fall.