Why go into debt?
Debt is not always bad. It allows people and companies to purchase things that they couldn't afford otherwise. Consumers purchase homes, cars and luxury items. Companies use debt in order to leverage the investment made in their private equity. The leverage is the proportion of debt to equity. It is an important factor in determining how risky an investment is. In general, the more debt per equity, the riskier the investment.
Debt is a sign of an optimistic society - the society believes in its future earnings capacity. However, it also indicates the lack of a strong work ethic and postpones the solution for present problems. For example, it can often be used to supplement income but in reality it is only increasing debt and delaying the payments.
Excessive debt has historically been blamed for making economic problems worse. For example, just before the Great Depression, the debt/GDP ration was very high. Economic agents had high levels of debt, while the stock market featured asset bubbles. When the economic expectations correct themselves, deflation followed. The debt became more expansive, and in order to reduce debt, economic agents reduced consumption and investment. Drops in business activity led to further unemployment. Bankruptcies were prevalent because of increased debt costs caused by the deflation and to the reduced demand for products and services.
Many organizations are often able to find alternative
types of borrowing or even repayment arrangements that do not result in
bankruptcy. For example, some companies convert debt into equity in themselves.
The creditor is given dividends and capital gains in return for the discharge of
the debt and interest. These repayment arrangements will not cause bankruptcy,
because they are based on the borrower's earnings. The debt is discharged in
full, and the creditor becomes and investor in the company.