24 January 2012

Deleveraging debt

The graph above shows two decades of the trending of debt in ten countries.  Some will be surprised to note that the U.S. is not the top blue line - that's the United Kingdom !  And while the U.S. has started to "deleverage" since the 2008 crisis, for other countries the line is still rising.

Also of interest to me was this second graph, which breaks total national debt into its component parts.  In the U.S. since 2008, financial institutions have reduced their debt by 17%, household debt has fallen 11%, and corporate debt is down 7%.  Only government (presumably fed+state+local) debt has risen.  It may be that the latter has been necessary in order for the former three to be facilitated; I don't understand economics well enough to comment on that.  But I do think these two graphs are important.

Graphs from a report by the McKinsey Global Institute, via The Telegraph.  There are more graphs and discussion at both links.


  1. Debt deleveraging is important because eventually you're paying all of your current income to pay the interest on your debt (see Greece, Ireland and Portugal and Italy and Spain if they don't get their acts together soon). What those charts don't tell you is that more than 2/3s of the household deleveraging in the US was due to people defaulting on their credit cards and walking away from their mortgages (not really sustainable).

    Greece and Portugal are going to leave the Euro - their big problem is that they're not competitive with Germany and France, but they can't devalue their currency to make themselves competitive because they have the same currency as Germany and France. That can't be fixed with bailouts. Ireland, Spain and Italy won't be far behind.

  2. Yea, along the lines of what Bub says above, I think a lot of the nongovernmental 'deleveraging' was simply shifting the burden to the government. Someone pays when someone defaults, and if it's not a company or the bank, it's the government (and eventually those who pays taxes).

    Which is why all the talk about taxes in the Republican campaign is more than classist rumbling and hot air. Fundamentally, it's about who should pay the incurred debt.

  3. I'm entirely ignorant about this: exactly what does it mean to "deleverage debt"? Can someone clearly explain what it means to leverage and deleverage anything?

    1. I think the sense in which the word "deleverage" is used here is slightly suspect (but not completely wrong).

      Let's start at the beginning. Leverage is used by analogy with the kind of mechanical advantage one might get by using a lever to move a heavy object.

      Let's say it is December 1980 and you have 1,000 dollars. You also think that this new Apple company might be on to something. If you invest your 1,000 USD you can buy 363 shares at the IPO price of 2.75 USD/share. Seven years later you will have 5,380 USD as the price has risen to 14.82. A profit of 4,380 USD. No leverage was used.

      Instead, if you borrow money you can magnify your gains or losses. This is called leverage. Let's see an example.

      It is December 1980 again and you still have 1,000 dollars. You are pretty darn sure this Apple thing is going to be good so you decide to borrow 9,000 dollars from the bank at 5% interest and use that to buy apple shares also. So now you have 10,000 dollars and you can buy 3,636 shares of stock. Seven years later you have 53,885.52 USD worth of Apple stock, but you have had to pay 1,685 in interest to the bank plus the original principal of 9,000. So in total you profited 42,200 USD. That is a LOT more than the case above where you just used the money you had. Leverage multiplied your gains almost 10x.

      However the kinfe cuts both ways. If, instead of rising about 540% in seven years, the stock had dropped from 2.75 to 2.50. That is a loss of about 10%.

      In the unleveraged case you would have 363 shares worth 2.50 USD each or about 907 USD. The stock lost about 10% and therefore you lost about 10% of your original 1,000 USD.

      In the leveraged case you have 3,636 shares each worth 2.50 USD for a total of 9,090 USD. You have to pay the bank back 10,685 (9,000 principal + 1,685 interest). Now your initial 1,000 USD is gone and even after selling all of your stock you still owe the bank 1,568 USD.

      So using leverage when there was a 10% drop in share price moved you from 907 USD to -1,568 USD. You did 2,475 USD worse than you would have if you hadn't borrowed any money.

      A helpful videos :

    2. From this use a slightly sloppy usage of "leverage" comes into play. It starts to mean simply "borrow" or "go into debt". Which isn't quite right. It really means "borrow in order to invest in an asset that you expect to grow in value".

      Corporations borrow to invest in new machinery they couldn't otherwise afford and banks borrow money from the fed at criminally low rates and invest in (nominally) perfectly safe investments.

      There is a limit to how much they can borrow (like a credit limit). But for them it is expressed as a ratio. For example: for every 1 dollar they have they may be allowed to borrow 5 dollars more. So their leverage limit might be 5:1 (read "five to one"). If today they are only borrowing 4 USD per dollar they have then they are "leveraged at 4:1".

      So for an organization to "deleverage" means to reduce that ratio. They can do that in one of two ways. They can increase the number of dollars they have. Or they can decrease the number of dollars they owe by paying them back.

    3. Thanks, nolandda, that makes things a lot clearer.

  4. FFS, DEBT is not primarily an issue of financing the state's expenses. It's a tool to redistribute money from tax payers to those who own government bonds. That is the only reason (besides historical ones) why rich countries have the highest debts.

    Both the bond-holders and tax-payers can benefit from this arrangement depending how inflation develops. Unfortunately for tax payers inflation rarely ever surpassed the interest rates of bonds. Thus debt is a historical injustice that no government is able to correct, because campaigns are all funded by bond-holders. Instead politicians use the fairy tale of economic growth, which means in total the middle and working class would have to work either more or work harder (increased productivity), sounds terrific, NOT?

    In short: economic growth is BS for developed countries, politicians are either half-wits or liars or both, tax payers are fucked. But in the end we may be better off taking away the money of the working masses in this manner, instead of letting them vote with their moneys for idiotic entertainment and wasted natural resources. Instead this money could be spent much more wisely by the upper class. Ivy league schools instead of an MMA gym, that sort of trade off.

    Private Sector deleveraging likely came to pass as a result of taking away poeple's securities that they used to refinance.

    Deleveraging means reducing the debt to GDP/income ratio.


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