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[...] There are three reasons to believe that, before the crisis, the banking sector as a whole became too large. [...] The belief that when in trouble banks will be bailed out by the state because they are too important to fail leads to an implicit subsidy, which means a larger banking system than…

Financial engineering allows banks and shadow banks to manufacture additional assets almost without limit. This has had two consequences. First, the new instruments created are traded largely among big financial institutions and so the financial system has become enormously more interconnected. [..…

[...] There was a view that being very clever was a justification for making money out of people who were less clever. This attitude encouraged the arrogance of the traders who rigged and fixed prices in what were thought to be competitive markets. [...]

Banks, too, faced a prisoner's dilemma. If, before the crisis, they had exited the riskier types of lending, stopped buying complex derivative instruments and reduced their leverage they would, in the short term, have earned lower profits than their competitors. The chief executive would likely hav…