This financial practice involves purchasing assets, most commonly stocks, by paying only a percentage of the asset’s total value upfront and borrowing the remaining amount from a broker. The investor then repays the loan over time, typically with interest. For example, an individual might pay 50% of a stock’s price with their own funds and borrow the other 50% from their broker. This borrowed capital allows the investor to control a larger asset position than they could afford outright.
This method played a significant, and ultimately destabilizing, role in the lead-up to the Great Depression. The ability to leverage investments amplified both potential gains and potential losses. During the economic boom of the 1920s, many investors utilized this strategy, driving stock prices to unsustainable levels. The inherent risk was that if the asset’s value declined, investors would not only lose their initial investment but also be responsible for repaying the borrowed funds, potentially leading to financial ruin and contributing to widespread economic downturn.
