I have no idea what the ideal leverage ratio should be among lenders but it’s reasonable to conjecture that it should not exceed 10:1. For the past twenty years I have been sufficiently fortunate to maintain a zero balance on my credit cards each month. I often wondered why the credit companies are so generous to continue to carry me without charge and tolerate 0% which strikes me as a losing proposition by granting me this grace period—that is, until I began to think in terms of leverage. They need me and millions of others to remain solvent by reducing the leverage as they continue to accept minimum payments from millions more. The same applies to savings bank accounts wherein the larger the balance the greater to a point the larger the interest rate for the depositor.

In normal times there were foreclosures—even in the 40s and 50s among GI loans, though backed by government guarantees—but most conventional mortgages required 20-30% up front to keep leverage low. Still, the drastic reduction of up front requisites had less to do with the current crisis than the lunacy of wholesale refinancing on the strength of an endless spiraling of home prices. In the old days refinancing the home was contingent on the additional amount of the new loan being aligned with the value of home improvement, or an iron-clad payoff of other debts.

Let us hope with the new infusion of monies to the financial sector that they do not continue the same anything-goes mode and get back to the practice of sound finance . I would also add that investors in returning to the market should base their decisions on strong price/earning ratio.

Copyright © 2008 Richard R. Kennedy All rights reserved. Revised: Nov 26,  2008.

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