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Tuesday, July 23, 2024

Extreme Leverage vs. Common Sense

Author: Mark Dixon
Friday, March 6, 2009
3:07 am

By any measure, our economy is facing enormous challenges.  My good friend Bala Subramanian sent me a link to an extremely sobering piece from The Market Oracle comparing the current economic meltdown with the last two decades of economic turmoil in Japan.  We’re in for a rough ride.

I am no economist, but is seems to my simple mind that our current woes are linked to one major fact – that too much of the economy has been built on extreme leverage and personal greed, with too little emphasis on real production and common sense.  Now, the highly leveraged financial system is tumbling down like the house of cards that it really is.

Against that backdrop, may I offer a couple of illustrations:

Yesterday, the mighty Citigroup ($C) became a penny stock – trading under a dollar per share and closing at $1.03.  So, Sun Microsystems’ ($JAVA) beleagured per-share stock price is four times that of Citigroup! Little old Sun’s market cap is $3.4 billion.  Mighty Citigroup? Only $6 billion. 

Will Citigroup survive? Will it be nationalized? If it falls, what other domino disasters will follow in its wake? Only time will tell.

To be sure, these two companies are like apples and oranges, but I think this illustrates an important point.  Sun’s worth and potential is based on innovation and real production. Citigroup, on the other hand, was built on extreme leverage and personal greed. Far too much risky debt.  Complicated derivatives that masked underlying weakness.  Growth at the expense of common sense.  Now the cards tumble.

Perhaps the smartest financial thing I ever did during the dot com bubble was to cash out technology stocks in my IRA and pay off my house.  People told me I was absolutely crazy then.  But now?  Perhaps high leverage is not all it was cracked up to be.

Yes, we have big challenges at Sun.  All is not rosy here.  But I invite you to listen to the insightful video blog Jonathan Schwartz shared this week:  Understanding Sun in Three Easy Steps.  Think about Sun’s conservative financial management style that consistently generates positive cash flow. Think of $3 billion in cash on hand.  Think of Sun’s enormous investment in R&D even in the face of extreme financial pressure.

I’d rather be at Sun than Citigroup right now.  Reminds me of paying off my house.

One other point … is it any cooincidence that GM and Chrysler teeter on the brink of bankruptcy with their hands held out to Uncle Sam while Consumer Reports rates those two automakers dead last in its annual Automaker Report Card

Food for thought.

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