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Modeling Financial Crises: A Schematic Approach

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Executive Summary

The root cause of financial crisis is the initially gradual and eventually rapid separation of expected returns from what the real economy can actually generate. Ultimately, evidence of the relative under performance of the non-financial sector will become known. Shock, negative repercussions, and contagion result. Depending on the magnitude, the economic impact can be significant and even catastrophic. This phenomenon is, given the current structure of market economies throughout the world, systemic. It does not require "Crony capitalism," unique events, or government "Interference" with the market mechanism - it is, in fact, the market mechanism itself that causes this outcome.

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