If short-term interest rates are low but unstable, investors will hesitate before leveraging their bets. The low volatility of the Great Moderation increased the temptation to “leverage” in this way. They also made it profitable for such outfits to borrow and use the extra cash to amplify their investments, on the assumption that the returns would exceed the cost of borrowing. Low interest rates created an incentive for banks, hedge funds and other investors to hunt for riskier assets that offered higher returns.

That capital flooded into safe American-government bonds, driving down interest rates. The Fed’s defenders shift the blame to the savings glut-the surfeit of saving over investment in emerging economies, especially China. Some accuse the Fed of keeping short-term rates too low, pulling longer-term mortgage rates down with them. Economists still disagree over whether these low rates were the result of central bankers’ mistakes or broader shifts in the world economy. Investors sought out these securitised products because they appeared to be relatively safe while providing higher returns in a world of low interest rates. They were far too generous in their assessments of them. The agencies were paid by, and so beholden to, the banks that created the CDOs. Investors bought the safer tranches because they trusted the triple-A credit ratings assigned by agencies such as Moody’s and Standard & Poor’s. The pooled mortgages were used to back securities known as collateralised debt obligations (CDOs), which were sliced into tranches by degree of exposure to default.

Starting in 2006, America suffered a nationwide house-price slump. The big banks argued that the property markets in different American cities would rise and fall independently of one another. Pooling works when the risks of each loan are uncorrelated. These risky mortgages were passed on to financial engineers at the big banks, who turned them into supposedly low-risk securities by putting large numbers of them together in pools. Loans were doled out to “subprime” borrowers with poor credit histories who struggled to repay them. The years before the crisis saw a flood of irresponsible mortgage lending in America. All these factors came together to foster a surge of debt in what seemed to have become a less risky world. Some research also implicates European banks, which borrowed greedily in American money markets before the crisis and used the funds to buy dodgy securities. A “savings glut” in Asia pushed down global interest rates.

The “Great Moderation”-years of low inflation and stable growth-fostered complacency and risk-taking. The macroeconomic backdrop was important, too. Central bankers and other regulators also bear blame, for it was they who tolerated this folly.

The most obvious is the financiers themselves-especially the irrationally exuberant Anglo-Saxon sort, who claimed to have found a way to banish risk when in fact they had simply lost track of it. With half a decade’s hindsight, it is clear the crisis had multiple causes. The effects of the crash are still rippling through the world economy: witness the wobbles in financial markets as America’s Federal Reserve prepares to scale back its effort to pep up growth by buying bonds. GDP is still below its pre-crisis peak in many rich countries, especially in Europe, where the financial crisis has evolved into the euro crisis. Massive monetary and fiscal stimulus prevented a buddy-can-you-spare-a-dime depression, but the recovery remains feeble compared with previous post-war upturns. Even so, the ensuing credit crunch turned what was already a nasty downturn into the worst recession in 80 years. It took huge taxpayer-financed bail-outs to shore up the industry. THE collapse of Lehman Brothers, a sprawling global bank, in September 2008 almost brought down the world’s financial system.

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