A Second Financial Crisis May Be More Likely Than You Think

John Authers
John Authers

Since the depths of the financial crisis last winter, stock markets have rallied sharply. But despite the spurt of soul-searching in the wake of the crisis, surprisingly little changed even with the pain inflicted by the Great Recession, says John Authers, who edits the Lex column for the Financial Times and is the author of The Fearful Rise of Markets. In a video interview with DailyFinance, Authers argues that the chances of another crisis are, therefore, much higher than most investors realize (see below).

Authers isn't alone in sounding the alarm. Legendary hedge fund manager George Soros recently said the financial crisis is entering a second phase. But whether another meltdown materializes in short order or not, many of the factors that Authers pinpoints in leading to the last synchronized, stomach-churning drop in financial markets not only persist but may even have gotten worse.

Moral hazard -- an emboldening of market participants who find themselves insulated from the negative consequences of their bets -- likely only grew after the worldwide bailout of many reckless investors. The supply of easy money that fueled bubbles across asset classes the last time around has only expanded as policymakers try to keep offsetting painful economic contractions. And world markets continue to be dominated by big fund managers who have incentives to exacerbate imbalances rather than promptly correct them, despite what textbook economic theory would like to believe.

Under a Veneer of Tranquility

Like the most recent financial crisis, the next one to emerge will also probably be dubbed a "black swan" event that resulted from the unlikely intertwining of highly improbable factors. But in The Fearful Rise of Markets -- a much-needed, meticulous but very accessible examination of the building blocks of financial markets -- Authers reveals foundations that are much different than most investors might imagine.

The real wonder may be how such rapidly shifting markets, packed with perverse incentives, manage veneers of tranquility for as long as they often do.