Carola,
Carola,
Thanks for the massive attack on my post. I didn't want to get into detail, but I guess your criticism warrents a response. Lehman has a short term funding crisis where lenders pulled their loans, and customers pulled their cash. Their leverage was at almost 30 times equity, thus the more leverage they have, the less room assets have to fall to wipe out its equity. Lehman recently redefined tangible equity on it's balance sheet. Previously, it had a cap on the percentage of “perpetual preferred stock,” a form of equity-like debt that doesn’t have a maturity date, in its equity. Now, it doesn’t have a cap.
You mean everyone in America doesn't have extra money laying around?? Get out of town!!! Geez, that wasn't meant to be a blanket statement. I specifically work with high net worth investors who DO have extra cash, so for THEM it is a good opportunity. But again, thanks for jumping down my throat, it was fun.
Well, leverage is NOT equity!! Leverage is borrowing money to magnify your returns. It is leverage that killed Lehman! Lehman borrowed too much money. They played a game of high-risk bets and borrowing money. Whereas on paper their profits grew but to keep profits growing they were taking on more and more risks. Anyone remember Enron?
For those who don't know what leverage is let's say you have $ 1,000 invested and it takes 20 % hit - you lose $ 200, you still have $ 800 equity.
With 2x leverage you borrow $ 2,000 and the same 20 % decline costs you $ 600. Sounds like an acceptable risk so far, you still have equity. But look at what happens to your equity after the loss. At 2 x leverage you end up with $ 2,000 of debt and $ 400 of equity (actual money on hand), therefore the resulting leverage is $ 2,000 ./. $ 400 = 5 x.
At only 5 x leverage (according to the above example $ 1,000 in equity and $ 5,000 borrowed) you have NO equity. That means your business cannot absorb another downturn/loss.
On the upside, let's say you make a 20 % gain instead of a loss, according to the above example you make a $ 1,000 gain (without borrowing the money you would have made $ 200 and lost no equity) but still have $ 2,000 in debt against it.
Lehman's leverage wasn't 5 it was 30 as you correctly stated. I wouldn't call that a short time funding crisis. Lehman was heavily invested in real estate holdings, anyone think Lehman's assets would have gone down even more over the next several months?
Now I understand that someone in your position, working with high net investors may think that this is a great opportunity to make money. But if you are someone like me who works with people who are just a heartbeat away from losing their jobs, their savings, their homes, their livelihood and their self-respect, things may look a little different. I am working with mid-level managers who lost their jobs in the last lay-off, I am working with middle class people who worked hard, paid their bills and were pretty well off until it all went to hell and a handbasket. This is where middle America is. They are not high net worth investors who think everything is hunky dorry and just a great opportunity to make more money.
I bet 90 % of people on this board are not high net worth investors, they are just struggeling to make ends meet and cancelling their $ 200 STS orders because it's not in their budget. You think it is wise for them to invest in securities and the stock market, even if they had a little bit of money. Rule number one, don't invest money in risky investments if you can't afford to lose it.
Kind of reminds me of how the housing bubble started.
