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It Is The Debt, Stupid

February 23, 2010

While Congress dithers on some sort of financial reform remember the facts:

Over the past several decades, rising debt levels characterized just about every part of the American economy.  But total debt outstanding rose particularly fast in the financial sector, surging from $578 billion (21% of GDP) in 1980 to $17 trillion (118% of GDP) in 2008.  In the years leading up to the crash, moreover, financial firms increased their leverage to dizzying heights, piling ever more debt on a dangerously thin foundation of capital.  Among domestic investment banks, gross leverage ratios grew from about 23-to-1 in the first quarter of 2001 to over 30-to-1 in the fourth quarter of 2007.  And that’s just what was visible on their balance sheets.  Off-balance-leverage rose dramatically higher, with contingent liabilities (including AIG’s notorious credit default swaps) inflating hidden leverage to truly extraordinary levels.

David Moss, the John G. McLean Professor at Harvard Business School and the founder of the Tobin Project.

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