Leverage Please

The past few weeks have not been kind to the leveraged companies and financial institutions in America. Their meteoric decline has yielded calls from those who were alive in the 50's and 60's when consumer credit was not widely available, to stop the over consumption. True, some people may have over consumed; however, this should not be confused with leverage.

Companies too apply leverage through borrowing, and often end up with debt levels which are many times their capital. The reason companies apply leverage in the first place is in attempt to raise their return on their own equity. The reason this leverage is productive and beneficial to the greater society is that these companies are really using leverage to capitalize on their competitive advantage. With leverage, a company can find what it does better than anyone else and exponentially multiply their returns. This is good, because this causes capital to be allocated in a more efficient manner, forcing companies to focus on their core competencies.

Politicians who are calling for the deleveraging of America should take a step back and think about what they are really saying. To me they are telling us that they want companies that have become experts in their industries to only produce at 20% capacity (reduction from 25 times leveraged to 5 times). If American companies are to compete globally, they better be able to bet the farm when the deck is stacked in their favor.