Simon Johnson and James Kwak - Lehman Brothers and the Persistence of Moral Hazard - washingtonpost.com

Simon Johnson and James Kwak - Lehman Brothers and the Persistence of Moral Hazard - washingtonpost.com:

"Moral hazard already existed in the system on at least three levels.

First, bank employees and managers had asymmetric compensation structures.....

Second, shareholders had the same payoff structure. Banks are highly leveraged institutions; every dollar contributed by shareholders is magnified by 10 to 30 dollars from creditors. This meant that in good years, shareholders benefited from profits that were juiced by leverage, but should things go wrong, they could shift their potential losses to creditors.

Third, creditors had only limited incentives to watch over major banks. Ordinarily, creditors should demand high interest rates on loans to highly leveraged institutions. However, the expectation that large banks would not be allowed to fail made creditors more willing to lend to them. This is why the failure of Lehman was such a damaging blow: It shattered market expectations that the government would not let a major bank fail."

A must read for corporate or banking/institution classes.