Seth's Blog : Leverage is brittle

Leverage is brittle

Debt is a financial miracle.

If you buy a property for 20% down, with the bank financing the rest, and it goes up in value by just 10%, your profit is 50%. (I’ll wait while you do the math.)

If you have a factory and can buy a machine that increases productivity, the money you borrow to pay for that machine creates enough profit that you get to do it again. And again.

Alas, the ratchet can also go the other way.

If that property goes down in value a little bit, you lose everything.

If your competitors buy better and more expensive machinery than you have, they can sell for less than you can, and your investment disappears.

Farming is difficult. It always has been. But leverage and debt make it a persistent challenge. If the weather is better than anyone expects and the markets are just right, you do really well for a season. But if conditions change, if fertilizer is hard to get, if there’s a glut–well, the bank still does fine, but the farmer can get wiped out.

The reason that supply chain issues were so bad is that leveraged organizations needed to figure out how to extract every penny from their cash flow, and having less inventory on hand seemed like a smart way to eke out a bit more leverage. Until a shipment is late and then it all grinds to a halt.

And… when a bank or an investor is considering two power plants, and they discover that the coal plant is 1% more profitable in the short run but 100x worse for the community, they go for pennies instead of resilience. Because leverage multiplies the value of a short-term penny so much that they feel as if they have no choice but to choose the fragile, selfish, short-term path.

Leverage accelerates everything. Learning to see it is a key step in understanding how to fix it.