In a nutshell, we experienced an enormous credit boom during a period before, characterised by an extreme undervaluation of risk. This was supported by favourable macro-economic conditions – not least, interest rates that were too low for too long. Excessive risk-taking was further encouraged by a lack of transparency and market failures in the process of credit risk transfer.
Pro-cyclicality in the institutional design of financial markets, such as capital adequacy rules, accounting rules and remuneration schemes, also encouraged extreme leverage in the financial system while they are now contributing to a fatal deleveraging. When the famous “wake-up call” occurred, financial markets panicked and suffered a massive liquidity shock.