Thursday, March 05, 2009
Corporate Leverage Did Not Cause the Bubble
The attached graph shows leverage ratios for Commercial and Investment Banks over time. There's a little jump at the end for investment banks, and I suspect a lot of that was due to the fact that as the Asset Backed market shut down mid 2007, all the stuff coming on their books they used to sell, they had to keep.
Note that many people say leverage caused the bubble. Only in a certain sense. Home buyers were too leveraged (no money down). Any owners of these assets were implicitly too leveraged by owning them. Basically, if the base constituents of the portfolio is leveraged, everything above it is too. But strategically, at corporate level, the Assets to Liabilities ratio was not a major player in this crisis. And, of course, no bank should ever own investment grade securities trying to make money on the spread.