Nov. 17, 2021

We Love To Borrow!

Americans simply love financial leverage. We use it in almost everything we do.

When we buy a new home or car, we borrow. When we go to the store, it's easy to use those automatic check-out machines, and pay with a credit card.

Most of our businesses, and seemingly all of our government, use financial leverage.

We love to put ourselves in debt.

This week there have been three major events that show how we use leverage.

The first, of course, was the signing into law of the massive Infrastructure Plan of President Biden. Build Back Better. This plan is so large, at 1.2 trillion dollars, that it's almost impossible to describe.

The financial impact of it all won't be fully known until the Congressional Budget Office, The CBO releases their Scoring on Friday.

But what we do know, is that every dime of that 1.2 trillion dollars is borrowed. Not one penny was raised for this project BEFORE it was enacted. There was no fund prepared as a down payment. Nothing, nada, it is borrowed out of whole cloth.

And the CBO has already projected that the interest on our currently existing debt, will become the largest single line item in our Federal Budget in the next 10 years.

That's right interest will be our largest financial obligation, larger than defense, larger than social security, larger than everything. Such is the cost of financial leverage.

But the Federal Government is far from the only place you can find financial leverage, private corporations have also climbed on the leverage wagon.

And the best example of this is the Home Depot. Everyone's favorite building supply, and home improvement store. Home Depot is the largest company in this sector, and they've built their company almost exclusively on debt.

You may have caught a podcast I did earlier on Home Depot, as the most leveraged company in America. Home Depot reported its latest earnings yesterday.

Now, in their most recently reported balance sheet, they report that the company is worth roughly 74 billion dollars. And guess how much of that is borrowed capital. Perhaps 25 billion borrowed? No higher. 50 billion borrowed, no higher still. Of the74 billion worth of the company, 73 billion of that is borrowed. Only 1 billion of Home Depot's worth is equity.

This is leverage to the max.

Finally, we come to Calpers, the giant California-based retirement fund. Calpers manages the retirement funds for 1.6 million California workers: the police officers, firemen, and city employees that work for state and local governments.

Calpers management is meeting this week to update their investment policy, among other administrative items.

Now Calpers has a problem. Although they currently have on hand a whopping $360 billion in assets. They are really underfunded by 150 billion. That is their projected retirement payouts exceed the amount they have on hand. They should be closer to 500 billion in assets currently.

So, on Tuesday, Calpers decided that they should enhance the return their receiving on their investments, by adding leverage. Beginning this week, Calpers will be able to borrow in aggregate 5% of the total value of their funds. Or about $18 billion dollars.

So there you have it, the three ways we put ourselves in more and more debt. Leaping at the idea to Build Back Better, Improve our Homes, and Plan for Our Retirements all by simply borrowing.

Now if there's one thing I've learned over the years: It's almost impossible to convince people that financial leverage is dangerous. And all the most so, when times are good.

When the money's flowing, leverage makes everything better. It lets you build, what you otherwise couldn't afford. To invest what you don't have the money for.

But when the cash flow dries up, it can go south in a hurry. We're seeing this currently in China, as their entire real estate sector struggles to make interest payments with steadily diminishing cash flow.

To imagine that it can't happen here is pure delusion.