ABSTRACT
If you had to summarise the sources of financial risk in a single word, one
reasonable choice would be ‘leverage’. Without borrowing, speculation might
damage speculators, but it is unlikely to damage anyone else. Once we allow
people to borrow, however, the whole financial system becomes risky. Failed
speculators can bring down the firms who lent to them as well as themselves.
Buying things on the ‘never never’, as my grandmother called it, is a business
that needs to be carefully managed by the borrower and the lender. In par-
ticular there is an interaction between solvency – whether a firm’s assets are
worth more than its liabilities – and funding liquidity – whether a firm can
borrow.
