Continuations

Today is the perfect day to be writing about government debt, the last installment in my series on debt. We have just seen in the most dramatic fashion why the US is such a great country. As I pointed out in my election day post, there will be some voices that will focus primarily on the constraints that Obama will face as president and most of those will point to government debt (and the cost of the Iraq war and the bailout of the financial sector). So do we also have a governmnent debt cris...

And now for the third installment in my mini-series on debt. Up today: financial sector debt. If you thought that the charts on household debt and corporate debt were eye popping, then you better put on some dark shades before you continue reading. As I pointed out in a previous post on the demise of Lehman, leverage in the financial sector has vastly amplified risk. Lehman clearly is not alone here. The following chart shows the growth of debt in the financial sector together with the growth...

Yesterday, I looked at household debt where it is clear that households took on too much debt. What about corporations? Credit was readily available and there was a lot of private equity activity. It is well-known that the net result was a big upswing in corporate debt starting in 2002. Again we can take a look at the Flow of Funds data from the Federal Reserve to see this. The following chart is in current dollars (so not adjusted for inflation) and shows corporate debt and profit before tax...

In thinking about the possible extent of the current economic crisis, I have been focused on understanding the role of debt. I first started looking at household debt. The Federal Reserve publishes statistics called the “Flow of Funds” which track sources and uses of capital in the economy over time. The following chart shows household debt, broken down into consumer debt (credit cards) and home mortgages, starting in 1966. The chart shows an eye-popping explosion in debt from a few hundred b...

A couple of years ago, I was telling a friend and neighbor (who was working at the New York Fed at the time), that I was concerned about the mountains of debt that were being used in buyouts. My friend was looking into hedge fund leverage for Timothy Geithner and agreed that someone ought to do the same for PE funds, but I don’t think anything ever came of it. My big concern back then was the appearance of a deal structure that struck me as having the wrong incentives. I was also worried that...

Entrepreneurs sometimes wonder why VCs are so bent on owning a 20% stake in the companies they invest in. The answer is surprisingly simple: It’s a successful heuristic. Heuristics are “rules of thumb” and they turn out to be really useful whenever you deal with a lot of uncertainty. As an investor, one might be tempted to try to optimize the ownership percentage on a deal-by-deal basis. But so much can go wrong with any particular company that such optimizations are likely to backfire – if y...

The Sequoia “RIP: Good Times” presentation: Super clear presentation about how we got ourselves into this mess and why it will take a long time to get back on track. Must reading for everyone (not just entrepreneurs).

Fantastic chart in today’s New York Times Week in Review Section with data from Robert Shiller. Shows clearly how Fed policy after the implosion of the dotcom bubble enabled the real estate bubble. Now we are likely to overshoot the long term average on the downside.

We may well be going through a 50-year storm in the financial markets. Lots of folks are talking about unprecedented events in the housing market and about the risks of financial innovation such as Credit Default Swaps. With so much change it may well seem like all the old rules are out, but at the heart of Lehman’s demise is a much much older killer - leverage. Leverage kills by vastly amplifying risk. It does so in a non-linear fashion which makes it really hard for folks to appreciate just...