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The blunders that led to the banking crisis - How the risk models failed the world's banks

Why didn't the banking industry foresee the crisis that afflicts it? By Rob Jameson

WHAT'S the quickest way to kill a bank? As recent events in the financial world have shown, the answer is to deny them access to ready cash. Over the past year, a string of banking institutions have found themselves in such a "liquidity crisis": unable to convince the market they can honor their promises to pay back money they owe. The result has been a series of high-profile failures, from Northern Rock in the UK last year to Lehman Brothers last week.

The crisis did not come without warning. Ten years ago this month, a giant hedge fund called Long-Term Capital Management collapsed when it too suffered a liquidity crisis. Yet banks and regulators seem not to have heeded the lessons from this wake-up call by improving the mathematical models that they use to manage their risk.

That raises two key questions. How did the risk modelers get it so wrong? And what can they do to prevent similar crises in future?