What’s your leverage ratio?

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I think I found the root cause of this whole financial crisis, just like the Wall Street investment banks, hedge funds, AIG (NYSE:AIG), Washington Mutual (NYSE:WM), the problem is American home buyers/consumers are overly leveraged. Note I used the word home buyers, not owners, because theoritically the banks (oh, to be precise, the Chinese, the Japanse…) owned the mortgages, most American buyers put very little downpayment. This problem is not isolated to the home mortgages, it has been extended to the auto loans and cosumer credit too. So I would not be surprised to see if those two things blow up in the near future.

This also bring an interesting question, related to the current heated debate on the bailout bill: Paulson (aka King Henry) does not want any string attached to his bailout plan, arguing that wihtout bailout the credit market will collapse and we will be all worse off; Democrats argues that we need to bailout the home owners (oh buyers, or speculators) too at the same time we bailout the wall street.

The bottom line is: we are both overly leveraged. While I saw the Lehman Brothers has 40:1 asset/equity ratio, what’s the American consumers leverage ratio? I remember more than 7 years ago I bought a car with zero downpayment, that’s an infinite leverage ratio. Seriously speaking, I think the old rule 3:1 for buying a house should still apply: in others words, people should buy a house about 3 times gross income. OK, I am talking about the solvency measurement here.

The aftermath of bailout
On the surface, the bailout will be unfair to the people play by the rules: people who buy the house they can afford; people who rent because they can not afford the house; people who pay the bills on time. But look at the other way, this event is far from over. The responsible people already are rewarded with better sleep at night, and perhaps picked up some good investments (like Buffett did) along the way.

So, my advice to myself is “no new car”, and take the leverage ratio I can afford 🙂

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