Excessive leverage leads to economic collapse from "summary" of The Money Culture by Michael Lewis
Excessive leverage is like a drug that lulls investors into a false sense of security. It tricks them into believing that they are invincible, that they can keep borrowing money to invest in more and more risky assets without any consequences. It is a dangerous game of borrowing more than one can afford to pay back, all in the hopes of making a quick profit. When investors become overleveraged, they are essentially playing with fire. They are taking on more risk than they can handle, and when the market turns against them, they are left holding the bag. Suddenly, the assets they bought with borrowed money are worth far less than what they paid for them, and they find themselves in a precarious position. As the market continues to decline, these overleveraged investors are forced to sell off their assets at fire sale prices just to meet their margin calls. This selling only serves to drive prices down further, creating a vicious cycle of panic and selling. The market spirals out of control, and before you know it, the entire economy is in freefall. The collapse of Long-Term Capital Management in 1998 is a perfect example of how excessive leverage can lead to economic collapse. This hedge fund was highly leveraged, with a debt-to-equity ratio of 25 to 1. When the markets turned against them, they were unable to meet their margin calls and were forced to liquidate their assets at distressed prices. The fallout from Long-Term Capital Management's collapse was felt far and wide, as banks and financial institutions that had lent them money were left holding the bag. The Federal Reserve had to step in to orchestrate a bailout to prevent a full-blown financial crisis. Excessive leverage is a dangerous game that can have dire consequences. It may seem like a shortcut to riches, but in reality, it is a surefire way to financial ruin. Investors would do well to heed the lessons of history and avoid the siren song of leverage at all costs.
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