Understanding ‘leveraging’ and the financial meltdown

Document type
Paper
Author(s)
George Irwin
Publisher
Compass
Date of publication
14 October 2008
Series
Thinkpiece; 39
Subject(s)
Social Policy
Collection
Social welfare
Material type
Reports

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This paper explains the role of leveraging in the 2008 financial crisis. ‘Leverage’ is the term for borrowing money to supplement one’s own, something most individuals do when buying a home. However, since the advent in the 1980s of Collateralised Mortgage, Debt and Loan Obligations, and with the deregulation of the financial services industry, leveraging has become an extremely lucrative part of the financial sector. Increased leverage allows a greater rate of profit, but the greater the leverage the more unstable it becomes and the more people (and institutions) can get hurt. The author traces the changes in the financial sector through to the 2007 subprime mortgage crisis and examines what is likely to happen next. Because hedge funds and investment banks now provide such a large proportion of market liquidity, credit contraction will be far worse than in previous cycles. The financial market is huge: its growth since 1980 is unprecedented. The value of financial assets---bank assets, equities, private and public securities--increased from $12 trillion in 1980 to an estimated $140 trillion in 2005. The coming recession will be wider, deeper and longer than most commentators care to admit.

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