A Flawed Solution: The Difficulties of Mandating a Leverage Ratio in the United States – Note by John Holman

From Volume 84, Number 3 (March 2011)

While the causes of the recent financial crisis have been debated extensively, the conclusion that excessive leverage by financial institutions contributed to the crisis has garnered widespread support. Concerns over the role of leverage have spurred a renewed focus on banks’ ability to exploit the presence of moral hazard due to limited liability and the government’s tendency to rescue banks in distress. The crisis painfully underscored how banks use leverage to increase their expected returns while simultaneously shifting risk to creditors and the public at large.