Amid the havoc of the world financial crisis various measures are being proposed to tackle it as well as forestall a similar collapse in the future. The crisis, now global, originated in the United States and some economists are understandably searching for explanations in the US economy itself. To them, the main reason for the crisis lies in dramatic structural adjustments in the American economy and, in particular, spectacular shifts in its real estate sector. In recent years, on the eve of the crisis, the US exported many jobs to countries like China and India without compensating for that flight of labour. Without protectionist measures many US economic sectors have faced a decline. This has also made it impossible for employees of those particular economic sectors to pay back loans and mortgages. The result has been massive defaults and a follow-up wave of bank runs.

Others blame excessive competition in the banking sector that stimulated banks to extend too much credit. Indeed, credit expansion in many countries that now are suffering from the world financial crisis has, in recent years, reached an unprecedented high. Economists, however, have not credibly explained the reasons behind this dramatic worldwide credit expansion. The fact that there has been excessive competition in the banking sector has led some to presume that when markets are too free, they are somehow deleterious. Others may believe that capitalism should be substituted by a Marxist type of economic system. Yet this model has already proven unsuccessful.

Clearly, regulation on the part of the government was insufficient. Not that it was missing, but perhaps it was not of the right type and it was rather poorly timed. It would appear that in important and turbulent areas such as banking and finance, governmental intervention may be more necessary than elsewhere.

Many pundits attribute the crisis to financial gurus who developed sophisticated monetary instruments whereby banks and financial institutions packaged their debt and resold it to others. The recipients of this debt, in turn, resold it to others in a chain mechanism designed to transfer their risk to someone else.Even experts in the field find some of those sophisticated financial derivatives hard to comprehend.

All the above are possible explanations for the world financial crisis. Probably all of them contributed to it in their own manner. However, the main reason for the crisis seems to be none other than the managers of all the banking and financial institutions involved. The aforementioned factors appear to be just symptoms of a mode of behaviour so mispaced that it has triggered the most serious crisis the world has seen in the past century since the Great Depression.

One should first ask why banks would give credit so liberally when the long-term sustainability of such an action might be dubious. The answer is that bank managers rarely have long-term incentives - their goals are more often than not short-term. This leads to the standard principal-agent problem where the interests of the principal and the agents diverge. In the context of banks, the principals are the owners and creditors of the bank who have a vested interest in maximising their bank's present stock. Bank shareholders thus have the long-term goal of creating a solid and stable institution. The principal is generally interested in the reputation of his firm or value of his property, since he would receive a continuous stream of income reaping the fruits of that reputation. The bank's numerous depositors generally also aim to secure the long-term health and stability of the bank. Depositors, for the most part, also have long-term incentives - stable banks provide them with continuous returns on long-term deposits. But even if a depositor makes a short-term deposit, he would still be worried if his particular bank or the entire banking system were shaky.

In contrast to depositors, bank managers usually have short-term horizons and goals that often conflict with those of their principals. Bank managers try to maximise their own wealth and this usually is a short-term incentive. By handing out excessive credit, bank managers actually create money and increase the money supply. This process, known in economic theory as the money multiplier, is a successful tool for bank managers to enrich themselves at the expense of all other economic players. By increasing money supply, banks cause a dramatic increase in aggregate demand. Increased aggregate demand further pumps up the real estate market or creates other bubbles, pushing up prices and making the respective industry highly profitable in the short run.

The simple economic principle is that demand without money is no demand and that someone's desire to buy becomes real demand only when backed with income. The availability of funds thus creates true demand and drives people's desire to own expensive houses and luxuries, which, otherwise, they would be unable to afford. Without money in their pockets, ordinary consumers would not be tempted to buy or undertake such costly projects. The desire to own a flat, plus the ability to pay for it, is what constitutes demand in the housing market and makes it seem a highly lucrative investment.

Stimulated prices make investment projects look highly profitable and that is exactly what bank managers' bonuses depend on. Their remuneration and perks depend on the short-term profitability of investment projects, not on their long-term sustainability. Long term, most of these projects would seem likely failures. However, their short-term returns, given the money multiplier process, are extremely high.

In view of the real estate bubble, one can easily see that bank managers have intentionally stimulated demand in the housing sector to make it a high-yield industry. Clearly, those investments would be unsound in the long run with the adverse effects of over-construction but bank managers are frequently unconcerned by the long-term viability of investments.

Various bank experts and employees nowadays blame the crisis on the bubble that arose in the real estate sector. What they omit to mention is that this would not have occurred in the first place without the participation of the banks and that, behind that participation, stand bank managers. Bank managers, in fact, have for the most part caused the bubble - whether in real estate or elsewhere. Without real money in their hands, supplied by banks, consumers would rarely be able to buy property, so a bubble would be unlikely to emerge.

In their goal to maximise their own usefulness bank managers have benefitted greatly from the phenomena taking place in recent years in economies worldwide. Numerous data show the excessively high salaries and bonuses received in various banks in the last years. Chase Manhattan Bank reported an average annual salary of nearly $500 000 in 2007 in its London office, including also the salaries of janitors and secretaries. Similar numbers can be found for all the failing banks as well as many of those still functioning. Although salaries are not directly related to the returns of investment decisions, bonuses are entirely driven by the profitability of those projects and it is short-term profitability that affects bonuses. So it is that bank managers have an incentive to stimulate yields in the short run, not in the long run. The housing sector - and indeed other consumer-orientated sectors - are the most suitable areas to achieve such short-term profitability.

Bonuses received by bankers depend on the short-term profits of banks irrespective of whether it is the US, Bulgaria or Britain. And everywhere the same trends or patterns confirm the hypothesis that bank managers caused the world financial crisis that is now undermining the global economy, and is threatening to become a global economic slump.

In all of the failing banks in the affected countries bank managers gave out loans to people without income or with irregular, uncertain income. Acting irresponsibly, they rarely made the necessary investigation as to how reliable the prospective debtor was, what his probability of defaulting was, etc. Diverse examples of loans with "favourable conditions" exist - low-interest loans, interest-only loans, exempt periods, loans without proof of income or origin of income, loans without collateral or loans for which the collateral is the real estate property itself. And in almost every country, the housing bubble was the mechanism behind bank failures - from the US to Germany to Belgium.

Bankers know portfolio theory well - every good financial textbook says you should diversify and not place all your eggs in the same basket. In the context of the real estate bubble, this means that no matter how attractive the housing market is, you should not invest only in real estate. Prices go down just like they go up. Indeed there is nothing inevitable about price rises. Bank managers were fully aware that there would be a limit to this growth and that prices of real estate could start falling. But instead of giving credit to other businesses, as good portfolio theory would dictate - or as the bank's safety and stability would require - they instead invested all "their eggs" in the real estate basket exclusively. Why? Because the real estate basket is the one in which profits can skyrocket most quickly short-term and so enable bank managers to extract the greatest amount of wealth.

In the banks' investment decisions, therefore, other areas of production or services would be greatly ignored and most of the banks' capital would go into construction, a business whose long-run credibility and prospects are somewhat unclear. This again shows bankers' incentives to maximise their own wealth rather than ensure the bank's health or represent the interests of the principal.

The sophistication of financial instruments also confirms the fraud that took place in the banking sector. Risky debt with the possibility of high returns was issued so that high salaries and bonuses could be received. Then this debt was restructured and resold to others in a chain mechanism where the risk of chain failures was ignored, although even the uninitiated could easily foresee this domino effect.

We should stress, however, that while bank managers' misconduct was the trigger for the world financial crisis, there have been plenty of factors aiding and abetting this behaviour. Backed by governmental promises to keep the financial system secure and sustainable, bank managers have frivolously undertaken highly volatile and risky projects that accrue immense perks. It's now common for governments of Western democracies to guarantee the safety of deposits in full. Prime ministers often seek to pacify the public that their deposits would be fully ensured in case of bank runs and that bailout plans are the responsibility of the government. Furthermore, backed by the central bank as a lender of last resort, managers of commercial banks have behaved in a way that throws caution to the wind. This is the behaviour of an individual who, when insured, becomes more negligent and less prudent about the risks against which he is insured. In their own utility-maximisation efforts, bank managers have spread out the risks and the burden of the crisis to the general public as well as ordinary taxpayers and governments. They were motivated in this by their own greed, not by concern about the collapse of the global financial system.

As to governments, it has long ago become obvious that they have not regulated banks enough. Governments have failed to steer the money-multiplier process and prevent inflation generation. In areas where such inflationary trends have been obvious and bubbles such as the real estate were about to burst, and where the need for government intervention in the instruments of monetary policy has been pressing, no such actions have taken place. Governments could directly prevent the multiplier process by increasing the reserve requirement ratio or by manipulating equilibrium interest rates with the help of the discount rate. Anti-inflationary policies have thus become the primary task of government economic policies nowadays. This is the course of action governments should pursue in general but, mostly, in periods of expanding bubbles, in an attempt to avoid the growth of a bubble and also the formation of new bubbles. In an inflationary spiral one bubble often leads to another and causes a wave of rising prices in all sectors of the economy. For example, a dentist buying a flat at an inflated price would likely increase the price of his services, provoked by the increase in the purchase price of the flat. In so doing, he has automatically transferred the bubble elsewhere.

A legitimate question to ask is this: who are the losers of this adverse behaviour? Those are the very failing banks as credible institutions, their owners as well as their creditors, some of them who will lose their life savings. The government, in the form of ordinary taxpayers, is another loser from bankers' actions. Governments in affected countries such as the US, Britain, Iceland, France, Germany and Belgium all have to adopt bailout plans to rescue what is left of insolvent institutions. But, most importantly, it is the real estate sector and the economy in general that stand to lose the most from the system's failure.

The financial crisis is already transforming into a recession. This makes it harder for honest and indispensable businesses to borrow money, intensifying people's pessimistic expectations and causing a major global economic downturn. With their irresponsible behaviour the managers of wealthy and reputable - or what looked like reputable - banks have created the conditions for one of the most staggering recessions seen in the modern global economy.

Regardless of whether it's depositors or taxpayers that will now bear the burden of the bank crisis, the ordinary citizen is the true victim of this downturn. Every member of society has become a victim of the inflation generated by banks. This has been most obvious to those who in recent years tried purchasing a house or similar property for themselves. On the real estate market, people with good, secure and continuous income have had to compete with people with not-so-good, secure and continuous income. Honest, efficient and hard working individuals have been hurt by bubbles generated by the inflationary behaviour of banks and their officials. As a taxpayer, each citizen is a victim and a loser, since money that would otherwise go towards productive public or private investment will now go towards rescuing banks and financial institutions with a questionable role in the economy. As a defaulting debtor, the ordinary citizen is also a victim. He will now face bankruptcy due to the upcoming recession, falling income and inability to pay off debt.

Given the bankers' incentive mechanisms and driving engines, the world needs a more solidly founded banking system with stronger government participation and observance. It also needs a system that follows social interest and not that of an individual economic agent achievable at the expense of general economic efficiency and global economic stability.

*Tamara Todorova is an associate professor of economics at the American University in Bulgaria.