Risk did not go away when it was sliced and diced across market participants, and it was not as distributed and diversified as had been thought – in short, the amount of capital to insure against such risks should not have been reduced as much as it was. With the viability of counterparties in question, financial institutions needed to conserve capital and liquidity.
Perceptions of inadequate capital and liquidity cushions sparked a flight to liquidity and safety by those lending to financial institutions, beginning an unwinding of leverage that, in turn, has exacerbated economic weakness. As the market price of risk increased, more capital was needed for risks that had already been undertaken.