Tilted Forum Project Discussion Community - View Single Post - meanwhile, back in reality (bank crisis round 2)

hiredgun · 09-18-2008, 06:45 AM

This startling piece points to the central role of excessive leverage - permitted by relatively recent deregulation - in producing the current crisis.

The Big Picture | How SEC Regulatory Exemptions Helped Lead to Collapse

I think I said 14-to-1 earlier, but it turns out that was terribly conservative. Five broker-dealers - three of which have now gone bust - were given special permission by the SEC to lever up to 30:1 and even 40:1! Hurray for deregulation.

For those unfamiliar with leverage: let's say you have a million dollars to allocate. If you are 'gearing' 40 to 1, you would put up that million dollars to borrow 40 million and invest it. This works out magnificently if you win - a 1% return on your 40 million is really a 40% return on your initial cash outlay of 1 million. But if you lose, the losses are also staggeringly large. The idea when doing this is to hedge your plays in a number of ways so that it is unlikely you'll suffer a net loss, but the higher up you gear, the harder it is to pull that off...

09-18-2008, 06:45 AM	#94 (permalink)
hiredgun Addict	This startling piece points to the central role of excessive leverage - permitted by relatively recent deregulation - in producing the current crisis. The Big Picture \| How SEC Regulatory Exemptions Helped Lead to Collapse I think I said 14-to-1 earlier, but it turns out that was terribly conservative. Five broker-dealers - three of which have now gone bust - were given special permission by the SEC to lever up to 30:1 and even 40:1! Hurray for deregulation. For those unfamiliar with leverage: let's say you have a million dollars to allocate. If you are 'gearing' 40 to 1, you would put up that million dollars to borrow 40 million and invest it. This works out magnificently if you win - a 1% return on your 40 million is really a 40% return on your initial cash outlay of 1 million. But if you lose, the losses are also staggeringly large. The idea when doing this is to hedge your plays in a number of ways so that it is unlikely you'll suffer a net loss, but the higher up you gear, the harder it is to pull that off...