One Sherpa

When you come across something good it’s never too long before you come across another great piece.

I hope you enjoyed Paddy’s version of the financial crisis in a previous post. Now here he is again talking about how we got in a mess with untangling credit default swaps.

Some of you may not even know what a credit default swap is!! Paddy will help you understand this in layman’s language…

By the way, for those of you who saw the earlier post… Have you been inspired to do your own whiteboard video yet? I know that I’ve thought about mine and it is on the agenda to be done before Christmas!

Associate Professor Steven Keen has been writing for the Age over the last couple of months and giving quite some insight into how we got into this financial mess.

I particularly like the simple way he has explained it in one of his earlier articles, entitled Financial chickens are flocking home to roost (September 28th).

He writes:

“BUSINESS as usual” is over. What we have taken as normal times – the ups and downs of Western economies since the 1960s, and the “financial engineering” of the past two decades – have been underwritten by the greatest debt bubble in human history. The meltdown on global financial markets is merely a reflection of the fact that, one day, this bubble had to end.

….So much unnecessary debt was accumulated in pointless speculation that the only way to get rid of it is to write it off – to declare debt moratoriums.

Households may have been naive to take the debt on, but the financial sector was culpable in extending it. Ultimately, it must pay for this folly.

Many of you would have heard me talk about the difference between debt and equity and how the returns from each of them are different.

I believe that the type of return required by a lender determines how that lending will affect a business. When debt and equity get out of balance the way a business operates can be squeezed in a direction by its lenders.

Our definition of the types of return is:

• Debt lenders look for a fixed, known and limited return. This is normally paid as interest on regular basis.
• Equity lenders look for a flexible, unknown and unlimited return. This is normally paid as a dividend which can vary both in terms of timing and size of payment.

When too much debt gets into a business it loses it’s flexibility, along with it’s ability to be creative.

Think about this in light of Steven Keen’s comments above and reflect on how our economy is being affected by the debt bubble which he referred to. I’m interested in your thoughts.

Let’s all determine to get more equity into our businesses, squeeze out the debt and head into a position of creativity and flexibility.