Consequently bank lending booms may portend more mixed economic outcomes. Other studies in this vein suggest some of the mechanisms that might be behind the greater future volatility. First, banks have procyclical leverage: lending booms by banks are financed by debt, not equity. Consequently, the increased leverage of banks can result in a deterioration of the quality of bank lending through a type of moral hazard that can occur if debt becomes too easy for the banks to raise or if volatility in financial markets is suppressed. Another finding by Adrian and his coauthors is that banks’ incentives and ability to lend becomes highly sensitive to financial market volatility. When the economy is in the upside of the cycle, volatility and other measures of risk may be low precisely because of the abundance of debt financing, masking the level of underlying risk in the economy, which may lead to excessive, and eventually unsustainable, growth in bank lending. The procyclical leverage of banks is associated with other features of the financial economy and its dynamics. For example, the leverage of financial intermediaries influences the pricing of assets: once again, this feature can impart procyclicality to asset pricing. When risk measures are low during a growth and boom phase of the cycle, asset prices tend to be supported, but during the contractionary phase, asset prices can drop, with risk premia rising, which, in turn, can lead to further contractions in credit by lenders, resulting in a negative feedback loop that can amplify the initial shock to asset prices.
When the economy is vulnerable to a financial crisis – that is when the levels of debt are high and the macroeconomy is at or past a peak, and in some cases, a housing boom is ending – then financial intermediary leverage and the issuance of money-like debt instruments can become excessive. Such excess can lead to a rapid scramble to deleverage – that is, to reduce levels of debt, causing fire sales and failures of financial intermediaries, which, in turn, confers further distress on the financial economy and the working of the  12  Prior to October 3, 2009 the FDIC limit on deposit insurance was $ but was raised on that day to $ for a temporary period. The Dodd-Frank Act made the expansion in the insurance limit permanent. BIS central bankers’ speeches  7  macroeconomy generally, as important sources of credit are blocked from reaching households and firms. In essence, I’ve argued that there are two views of the mechanisms that could lead to a crisis: one is about excessive leverage or the scarcity of loss-bearing capacity that builds up in an expanding economy and the other is about the excessive provision of liquidity in the private sector, or excess private money creation. Of course, liquidity and leverage go hand in hand: Private money creation enables firms that issue it to take on high leverage, both in the financial and the nonfinancial sectors.