The Ingredients of Disaster

Financial crashes share four common ingredients: excessive leverage, asset price inflation, interconnected institutions, and a trigger event that breaks confidence. Each one is manageable alone. Together, they are catastrophic. In mid-2008, Lehman Brothers held about $639 billion in assets against roughly $26 billion in equity — a gross leverage ratio of about 24-to-1.

Think of it as a forest fire analogy. Dry conditions (leverage), accumulated fuel (overvalued assets), and dense interconnections (financial linkages) create the conditions. A single spark — a bank failure, an unexpected default — ignites the entire system at once.