Contract theoryFrom a legal point of view, a contract is an institutional arrangement for the way in which resources flow, which defines the various relationships between the parties to a transaction or limits the rights and obligations of the parties. From an economic perspective, contract theory studies how economic actors can and do construct contractual arrangements, generally in the presence of information asymmetry. Because of its connections with both agency and incentives, contract theory is often categorized within a field known as law and economics.
IncentiveIn general, incentives are anything that persuade a person to alter their behaviour in the desired manner. It is emphasised that incentives matter by the basic law of economists and the laws of behaviour, which state that higher incentives amount to greater levels of effort and therefore higher levels of performance. An incentive is a powerful tool to influence certain desired behaviors or action often adopted by governments and businesses. Incentives can be broadly broken down into two categories: intrinsic incentives and extrinsic incentives.
Lehman BrothersLehman Brothers Inc. (ˈliːmən ) was an American global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), with about 25,000 employees worldwide. It was doing business in investment banking, equity, fixed-income and derivatives sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking.
Savings and loan crisisThe savings and loan crisis of the 1980s and 1990s (commonly dubbed the S&L crisis) was the failure of 32% (1,043 of the 3,234) of savings and loan associations (S&Ls) in the United States from 1986 to 1995. An S&L or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members (a cooperative venture known in the United Kingdom as a building society).
Lender of last resortIn public finance, a lender of last resort (LOLR) is the institution in a financial system that acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank lending market when other facilities or such sources have been exhausted. It is, in effect, a government guarantee to provide liquidity to financial institutions. Since the beginning of the 20th century, most central banks have been providers of lender of last resort facilities, and their functions usually also include ensuring liquidity in the financial market in general.
Too big to fail"Too big to fail" (TBTF) is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the greater economic system, and therefore should be supported by government when they face potential failure. The colloquial term "too big to fail" was popularized by U.S. Congressman Stewart McKinney in a 1984 Congressional hearing, discussing the Federal Deposit Insurance Corporation's intervention with Continental Illinois.
Systemic riskIn finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to the risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the entire system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries".
SecuritizationSecuritization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing.
Bank regulationBank regulation is a form of government regulation which subjects banks to certain requirements, restrictions and guidelines, designed to create market transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things. As regulation focusing on key factors in the financial markets, it forms one of the three components of financial law, the other two being case law and self-regulating market practices.
Agency costAn agency cost is an economic concept that refers to the costs associated with the relationship between a "principal" (an organization, person or group of persons), and an "agent". The agent is given powers to make decisions on behalf of the principal. However, the two parties may have different incentives and the agent generally has more information. The principal cannot directly ensure that its agent is always acting in its (the principal's) best interests. This potential divergence in interests is what gives rise to agency costs.
