Once leverage or borrowing gets into the game, the borrower needs
to generate the cash flow to service the debt and to generate
sufficient income to manage expenses and have enough left over to
get the return on equity boost leverage can bring. Credits get
shaky as debt service outlays begin to consume large portions of
cash flow. Credit quality erodes even faster when cash flow is
unstable and its visibility is called into question. Tossing about
leverage ratios without regard to how well debt is being serviced
and without a careful analysis of a borrower's income and cash
flows is an idle game.
Which brings us to the European Union where debt ratios are high
and where income / cash flow are now under pressure at the state
level. The economic recovery is but inching forward in the eurozone.
The revenue take of sovereigns is under pressure, and state
spending has been pushed higher to fund recession countermeasures
such as unemployment insurance. The problem is now being
compounded by sharply rising funding costs for Greece, Spain et al
as investors worry about debt service capability in the present
but down the road as well if greater austerity drags incomes further
down as a result of restructuring programs.
Sound thinker Edward Hugh holds forth on the subject for the
EU here.
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