Tuesday, February 24, 2009

More on Leverage

When I go to Las Vegas, I budget a certain amount of money to gamble with. I usually don't place one bet with all of the budgeted funds and I certainly DO NOT expect the casino to give me a "do-over" if I bet on red and the roulette ball lands on black........

The above graph (click to expand) summarizes the last few years leading up to the current debacle. I took the year end total assets of the selected firms and divided that number by the common shareholder's equity. By 2007, 30 to 1 (meaning that the firm held $30 in assets per $1 in equity, the other $29 was debt) was the norm. This means that A 3% LOSS ON TOTAL ASSETS ELIMINATES THE SHAREHOLDER'S EQUITY.

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