Wall Street Confidential

The Incredible Lightness of Leverage

October 10,2008

by Edward Jay Epstein


Leverage is at the heart of the current crises. If one dollar in assets is used to back $10 in debt, a bank is said to have leverage of 10:1.  The higher the leverage, the more shaky the financial structure.   The leverage at U.S. money center bank, including Citibank, J.P Morgan Chase and Bank of America, is about 12:1, but that number does not include the off-the-books collateral obligations, such as “revolver” lines of credit through which these banks are committed to loan.   Financial trading houses had been leveraged at least 25:1 prior to the bankruptcy of Lehman Brothers. Goldman Sachs, for example leverage ratio had risen to 26:1 in 2007, which meant just a 4% decline in the value of its assets would wipe out  its capital.

In Europe,the leverage is even higher. Deutsche Bank, for example, had leverage of 60:1 in September 2008. while some Russian banks have leverage of over 100:1. With leverage of 100:1, a decline of just one percent in the value of the assets would wipe out all these Russian banks' capital. Given such sky-high leverage, it is hardly surprising that confidence in the financial system is lacking.