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The Truth About Leverage

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By Ben Cohen

When I moved to the United States 4 an 1/2 years ago (I'd actually lived there as a teenager as well, but was not officially part of the economic system), I was amazed at the level of debt the average American lived with on a daily basis. Friend of mine owed hundreds of thousands of dollars in college fees, families had houses they clearly couldn't afford, and no one owned their own car.

While it was fairly normal to run up a bit of a credit card debt in England, it was peanuts compared to the thousands of dollars owed by Americans in similar situations."Dude, just lease - you can get a much better car that way" I was told on countless occasions. I didn't, based on the assumption that one day, I may not be able to pay my monthlies. "Just put it on your credit card," was another bit of wisdom passed on by many friends introducing me to American economics 101. I didn't, and have stuck rigidly to paying off credit cards in full the day they are due.

And thank God given the state of the economy and the precariousness of my chosen profession.

But Americans are told from day one that debt and leverage rules - it's the way to financial prosperity and the foundation of the American dream. Taking on debt is fine, as it's a down payment on your future. The problem is, leverage only works if the future can be predicted. And as we have seen, house prices don't always go up, and the economy doesn't always grow.

Megan McArdle, an alumni of business school writes:

I didn't get that $100,000+ job I was expecting; I ended up in
journalism, making less than half that. My loan payments ate up
something like 45% of my take-home, which made it extremely difficult
to live. Loan payments have limited upside for the investor. But they
have unlimited downside for the borrower: if you can't make your loan
payments, you're bankrupt, and out of business, or at the very least,
forced through an awful restructuring.

The strange thing with the American obsession with debt and leverage is that it has been adopted as a conservative principle. It isn't, and is in fact the polar opposite. True conservative economics relies on the principles of caution, modesty and calculated risk. Not the balls to the wall leveraging and speculation that we've seen literally decapitate the world economy. While some debt can be a good thing, too much can kill.