The Business Book

150

DEBT IS THE

W O R S T P O V E R T Y

LEVERAGE AND EXCESS RISK

I

n 2012, US theoretical

physicist Mark Buchanan

wrote Forecast, a book

detailing his investigations into

the workings of the economy. In

assessing the variables that affect

economic growth and decline, he

noted the importance that central

banks (and governments) place on

inflation, interest rates, exchange

rates, and consumer confidence. He

was puzzled by the absence of one

variable that had proved a central

factor in past extremes of boom and

IN CONTEXT

FOCUS

Managing risk

KEY DATES

1970–2008 Banks in

developed countries double

the ratio of loans that they

issue compared to the value

of money they hold.

2002 The Global Executive

Forum report on the collapse

of the Enron corporation says

that “the genius of Enron was

infinite leverage.”

2007–08 Increasing numbers

of people access credit to

finance mortgages, but later

default on their loans. Global

financial markets collapse.

2013 The UK government

forces banks to publish their

leverage ratios. Among the

highest leveraged is Barclays,

which has loans worth 35

times its (equity) capital base.

Increasing leverage

allows companies to...

Decreasing leverage

allows companies to...

...focus on growth and

convert short-term debt

into long-term loans...

...and pay increased

dividends to shareholders.

However, it can leave

businesses vulnerable

to cash-flow problems.

...focus on increasing profit

through minimizing costs

and repay long-term loans...

...and issue more shares.

However, the company

may fall behind rivals

who can boost growth

through higher leverage.