Wednesday, June 08, 2011

Deleveraging Defined

Deleveraging or de-leveraging is a financial term that has become increasingly common since the start of the current recession.

In finance we use the term leverage or financial leverage to describe the process of borrowing and using debt to help finance the purchase or acquisition of assets. It is no secret that borrowing is a way for a business or a person to acquire more money for a purchase and the more money one has the more they can buy.

Deleveraging refers to paying down and reducing debt. In business this usually involves the selling of assets and using the proceeds to repay debt. In many cases the assets being sold are ones that the business took on debt by borrowing money to purchase the assets they are now selling.

Deleveraging is a term that is also applied to individuals. Since the start of the current recession the term has frequently been used to describe reduction of debt by individuals.

While many individuals have done this by selling assets - homes, cars, etc. - the more common way is to accelerate the repayment of outstanding debts by devoting more of their disposable income to debt reduction rather than to other things. This has frustrated some economists and policy makers, especially those of the Keynesian persuasion, who have been counting on households to maintain their spending levels on consumer goods rather than on paying down debts.

Debt can be a useful tool for business, households and even governments when used wisely. However, after splurging on debt for the past couple of decades or so, the current spate of deleveraging is a healthy trend.

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