What really caused the magnitude of the current financial crisis, in my opinion, was the amount leverage used in the housing market and mortgage backed securities derived from it. Leverage is a double-edged sword that is a powerful ally during boom times, but can quickly become your worst enemy during the ensuing bust. The collapse or bailout of some of our most highly regarded financial institutions – Fannie Mae, AIG, Lehman Brothers and Merrill Lynch - was squarely due to leverage. What is leverage and how does it work? Here is a simplified example using three scenarios:
View detail |
