In 2008 the world financial system came close to a complete meltdown. No one wants a repeat of that terrible crash, but how can a repeat be avoided? In the first instance we need to understand what brought us to the brink - what we were doing wrong during the good times that was unwittingly leading us to the cliff edge.

Just what led to the meltdown?

Certainly there wasn't a single factor that was to blame. From the mid 1990s financial institutions were putting more and more money into new kinds of very risky investments. Some of these investments – like credit default swaps – are very difficult to understand (the New York Times called them "arcane" in one article) but the particular investments are a less important factor than the technique called leverage that was (and is) used to make those investments. Arguably, understanding what leverage is, is the key to understanding the meltdown.

So what is leverage? In essence, it just refers to the practice of borrowing money to make an investment.

To see how it works and to see both how attractive it can seem and how extremely risky it is, lets compare leverage with an old-fashioned investment.