Debt Vs Leverage

Generally, companies have two options when they wish to raise money. They can issue shares of stock, which are also

Leverage title screen

known as equities. Alternatively, they can issue bonds, which are also known as debt instruments. Leverage ratios tell investors how much debt a company has outstanding relative to the equity in their capital structure. I will write the above soon, lets discuss about Leverage and debt now.

Recently Sen. Rob Portman (R-Ohio) with Politico said, “Let’s use the debt limit, yes, as leverage.” As a practical matter, what he meant was, congressional Republicans should threaten to hurt Americans on purpose unless President Obama agrees to slash public investments. Because the White House won’t want such a catastrophe, Republicans will have “leverage” that Portman wants to see his party “use.”

In the finance world, debt and leverage are used interchangeably. Not so in everyday life. “Debt” has a negative connotation, as in something you (or your federal government) get buried in. “Leverage”, meanwhile, conjures a more positive picture of something moving or lifting for the better.

Leverage is not a dirty word. When an entrepreneur hires an employee, she is leveraging that person to expand her capabilities. When a professional takes out a mortgage, he is leveraging his future earning potential to increase his standard of living.

Leverage is a form of teamwork that accomplishes more good collectively than the individual parts could do on their own.

Now, if you’re eating rice and beans on the Dave Ramsey plan, I’m not trying to sell you a steak. Healthy discipline should follow unwise spending. It’s always the right time for self-control.

What I am suggesting is that careful lending has as healthful a place in an economy as currency itself. “Careful”, of course, is the operative word.

It makes no sense for me to loan the recent high school grad $40,000 for a new Mustang when the payment will be more than his apartment rent. It makes no sense for our federal government to be in $1.6 trillion of UNSECURED debt (though “only” $1.1 trillion is held by non-US government entities).

It makes a lot of sense for me to loan the single mom $10,000 to buy an efficient, reliable car with which to get to work on time. And it often makes sense for someone to borrow money at X% if he/she can in turn likely make X+Y% from another investment.

Appropriate leverage presents a borrower with an opportunity to keep a promise. It implies that he is trustworthy and capable of acting responsibly. We humans grow in positive ways when we make and meet commitments. In general, leverage promotes ownership and ownership strengthens a society.

Moreover, one could make a strong argument that the finance industry drove the technological and industrial innovations that have improved quality of life the world over.

In a perfect world, we all would have ample liquidity to bankroll all our purchases. Interest expense would be nonexistent. But in a balanced approach to pursuing life, liberty and happiness, interest expense may be a small price to pay for the progress it provides.

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