Leverage is how banks make such absurd sums of money. The Germans have a saying, “when you have two marks, spend one.” In modern banking that becomes “when you have one dollar in the bank, lend thirty or forty or more.” Leverage, the ratio of assets (loans and investments out in the world) relative to equity (reserve capital—the cushion you draw upon when things go wrong), rose precipitously throughout the 1980s and 1990s. If a major bank is running thirty times leverage, as was common in the run-up to the crisis, all it takes is a very small change in its asset values against its equity cushion to make it illiquid, if not close to insolvent. When securitized mortgages started to lose value in 2006, that very small decline became all too real, and the big banks that had funded themselves through the repo market (essentially borrowing overnight to loan for much longer periods with huge amounts of leverage on their balance sheets) saw their funding sources disappear. Liquidity, the very thing repo markets are supposed to provide, dried up, since no one was willing to lend to anyone else at normal rates. And because the banks were so levered up, they didn’t need all their funding to dry up—just enough to make them almost instantly illiquid.

Mark Blyth, Austerity, loc. 84