A New Buzzword: Deleveraging


It wasn’t that long ago that people were touting the extraordinary power of leverage. Use as little as possible to control as much as possible. Leverage was used in business and especially in real estate. You were considered an amateur if you put down 20% to buy a property, 5% and even 0% down became the rule rather than the exception. Businesses used easy money, or leverage, to expand their business empires. When used properly, leverage is a great tool. But it is also a double-edged sword that can lead to a fall that is as spectacular as the rise. How many businesses have failed and how many more will fail because they borrowed, or leveraged, more than was prudent?

Of course, it wasn’t only businesses and investors using leverage, consumers were doing it too. The run-up in real estate value caused so many people to feel richer than they really were. They then leveraged their homes, using home equity loans and bought things that made them feel very well off. The idea of $0 down and no payments or interest for 6 or 12 months made it seem like they were getting things for free. Of course, the piper had to be paid on that eventually.

Credit Fueled Expansion

What we had was an economic expansion that was fueled almost entirely by credit, or leverage. When the credit spigot was turned off the economy came grinding to a halt. It seemed like finding a living wooly mammoth or capturing Bigfoot was easier than securing financing for a real estate deal. Of course, the house of cards that was erected with all of this leverage came crashing down.

With the economy in shambles and facing the prospect of a total financial meltdown, the Government steps in to save the day. So how do they fix an economic catastrophe that was fueled by the use of too much easy money and credit? By borrowing more money of course! It’s like drinking a shot of whiskey to cure a hangover. Printing money that we don’t have is only using leverage to an extreme degree. The burden of this skyrocketing national debt will inevitably lead to inflation, and possibly hyperinflation. Governments that have over-leveraged their economies in the past (Article) have ultimately paid a heavy price.

More Than A Buzzword

Many corporations, large and small, are feeling the burden of excessive amounts of debt. In a shrinking economy they are taking steps to cut costs in order to remain profitable or even, in some cases, stay afloat. They talk of deleveraging in order to improve their balance sheets. In plain English, they know that they need to stop borrowing. If they don’t take these steps they may pay the ultimate price and cease to exist.

The entity with the greatest need to deleverage is the Government. Instead they keep creating more programs, more stimulus packages, and massive bailout plans. There are not enough tax dollars to pay for all this so they just use more leverage. Governments are not immune from failure, it has happened all throughout history. Economics has been the main catalyst for Government failure, don’t think it can’t happen here.

What can you do? Take steps to deleverage your own life. Avoid taking on any new debt and work to eliminate what debt you do have. Remember that leverage is a double-edged sword that cuts both ways. While you will generally use leverage, or loans, to do a real estate deal, be sure that it is manageable and that you have sufficient reserves to weather any storm. Avoid financing everyday purchases, do you really need that new flat screen TV or the latest electronic gadget? We all need to live within our means, if you want more, then increase your means.

A government big enough to give you everything you want is a government big enough to take from you everything you have.
Gerald R. Ford

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  1. The best financial words of advice I have ever received are to remember these three things:

    1- Never spend Every penny that you make. Live well within your means
    2- You can always find new things to spend money on. You will never be satisfied when it comes to accumulating things you really don’t need.
    3- Budget for a little ‘Mad Money’ every month. This is money that you don’t have to account for that you can spend in any impractical way you want. If you want something that costs more then your allotted amount of Mad Money then you will just have to save up for a couple months.

  2. What a great article. It should be manditory reading for everyone. Leveraging has it place in business and personal spending but it needs to be controlled at all times. I’ve always believed in deleveraging but I never called it that … I called it debt reduction and boy does it ever feel great when the debt is all gone. Then when you buy something you don’t really need it doesn’t feel so bad.

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