Economic Capital
In the summer of 2006, bankers and financial engineers lived in a rose garden. Financial markets were booming, risk premiums were low, financial engineers and their models were in high demand, and regulators had adopted Basel II regulations, which many bankers expected would allow them to reduce their capital requirements and grow their business further. Two years later, the garden had changed into a wasteland with credit losses mounting on the products developed by the same financial engineers, and spreading like wildfire to other areas of the financial markets. As a result, a number of banks (nearly) failed, the two largest mortgage providers in the United States and the largest insurer in the world were de facto nationalized, investment banks became an endangered species, and a USD 700 billion bail-out operation was launched by the US government, later supplemented by additional measures, to regain the market’s trust in the financial system. Across the ocean, the crisis had taken its toll in the form of bank rescues in several European countries, notably Germany, the United Kingdom,
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