The world has recently been shaken by an upheaval in the financial sector comparable to that of 1929. These events in world financial markets have, to say the least, given economists pause for reflection. It is worth giving a schematic account of the unfolding of this crisis to see how it can be reconciled with standard economic theory or whether a serious rethinking of our theory is called for. The explanations given for the origins of the collapse of the structure are clear and convincing. Individual banks extended credit to those wishing to buy homes with little regard for the capacity of the borrowers to pay. If the unhappy borrower did not fulfill his obligations the bank recovered the home, the price of which was rising. The loans in question were distributed among banks worldwide, through instruments which packaged loans of varying quality together. This, we were told, was a good thing because it diversified the risk. However, with a weakening of the U.S. economy the number of defaulters grew and, worse, prices in the housing market no longer rose. At this point, banks started to examine their positions and to evaluate the losses and potential losses due to the “subprime” loans contained in the instruments they were holding. Many major banks found that their positions were more than delicate and began to seek ways of redressing them. However, the crucial problem was that banks did not know which of their counterparts were in trouble and thus stopped lending to other banks. The freezing of the interbank market brought the whole system to a halt since banks are constantly in need of being able to finance various transactions and habitually borrow from each other to do so.