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Wednesday, October 26, 2011

The Power of Leverage

One reason why the top .1 percent has been able to grow their wealth is that they understand the power of leverage.

Return On Equity Versus Return On Assets | ThinkProgress:


" Imagine that in 1990 bank CEO pay had been indexed to bank ROE. By 2007, CEO compensation would have reached $26 million. That is precisely in line with their actual payouts. If you believed ROE were a reliable performance metric, US bank CEOs would have had a watertight defence back in 2007. Instead, of course, we had ludicrously leveraged banks that were too big to fail and brought the economy down with them. [...] Imagine if the CEOs of the seven largest US banks had in 1989 agreed to index their salaries not to ROE, but to ROA. By 2007, their compensation would not have grown tenfold. Instead, it would have risen from $2.8 million to $3.4 million. Rather than rising to 500 times median household income, it would have fallen to around 68 times."

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