Search Results
Working Paper
The 2012 Eurozone Crisis and the ECB’s OMT Program: A Debt-Overhang Banking and Sovereign Crisis Interpretation
This paper develops a model to interpret the 2012 eurozone crisis and the ECB?s policy response. In the model, bank lending is distorted by debt overhang, banks hold sovereign bonds, and the government guarantees the bailout of bank creditors. A self-fulfilling pessimistic view of the economy can trigger a banking and sovereign crisis: with pessimistic economic expectations, the value of sovereign bonds declines, the bank risk of default rises, and the debt overhang distortion worsens; this leads to a contraction in bank lending and to a decline in economic activity, which confi rms the ...
Working Paper
The Optimal Response of Bank Capital Requirements to Credit and Risk in a Model with Financial Spillovers
This paper studies optimal bank capital requirements in an economy where bank losses have financial spillovers. The spillovers amplify the effects of shocks, making the banking system and the economy less stable. The spillovers increase with banks? financial distortions, which in turn increase with banks? credit risk. Higher capital requirements dampen the current supply of banks? credit, but mitigate banks? future financial distortions. Capital requirements should be raised in response to both an expansion of banks? credit supply and an increase in the expected future credit risk of banks. ...
Working Paper
Pipeline Risk in Leveraged Loan Syndication
Leveraged term loans are typically arranged by banks but distributed to institutional investors. Using novel data, we find that to elicit investors' willingness to pay, arrangers expose themselves to pipeline risk: They have to retain larger shares when investors are willing to pay less than expected. We argue that the retention of such problematic loans creates a debt overhang problem. Consistent with this, we find that the materialization of pipeline risk for an arranger reduces its subsequent arranging and lending activity. Aggregate time series exhibit a similar pattern, which suggests ...
Working Paper
Debt-Overhang Banking Crises
This paper studies how a worsening of the debt overhang distortion on bank lending can explain banking solvency crises that are accompanied by a plunge of bank asset values and by a severe contraction of lending and economic activity. Since the value of bank assets depends on economic prospects, a pessimistic view of the economy can be self-fulfilling and can trigger a financial crisis: If economic prospects are poor, bank asset values decline, the bank risk of default rises, and the associated debt overhang distortion worsens. The worsening of the distortion leads to a contraction in bank ...
Working Paper
Debt Overhang and the Retail Apocalypse
Debt overhang is central for theories of capital structure, yet credible empirical estimates of its effects remain elusive. We study the consequences and mechanisms of debt overhang using exogenous changes in the leverage of commercial retail properties. Identification comes from changes in property values occurring after pre-determined debt rollover dates. We show that debt reduces profitability by impairing property owners' response to negative shocks, reducing the business activity of their remaining retail tenants. For the median property, a 10 percentage point leverage increase causes ...
Journal Article
Breaking the ice: government interventions in frozen markets
When subprime mortgage defaults started mounting in 2007, financial institutions found themselves unable to profitably sell off these soured investments or raise new equity. As these institutions struggled to reduce their leverage, consumers and firms alike found it increasingly difficult to borrow, which helped trigger a deep recession. Within the context of two popular explanations for the freeze ? asymmetric information and debt overhang ? Benjamin Lester discusses the costs and benefits of policies aimed at thawing markets in a crisis, including direct asset purchases, equity injections, ...
Discussion Paper
The Costs of Corporate Debt Overhang Following the COVID-19 Outbreak
Leading up to the COVID-19 outbreak, there were growing concerns about corporate sector indebtedness. High levels of borrowing may give rise to a “debt overhang” problem, particularly during downturns, whereby firms forego good investment opportunities because of an inability to raise additional funding. In this post, we show that firms with high levels of borrowing at the onset of the Great Recession underperformed in the following years, compared to similar—but less indebted—firms. These findings, together with early data on the revenue contractions following the COVID-19 outbreak, ...
Working Paper
The Rise and Fall of Consumption in the 2000s
U.S. consumption has gone through steep ups and downs since the turn of the millennium, but the causes of these fluctuations are still imperfectly identified. We quantify the relative impact on consumption growth of income, unemployment, house prices, credit scores, debt, expectations, foreclosures, inequality, and refinancings for four subperiods: the ?dot-com recession? (2001-2003), the ?subprime boom? (2004-2006), the Great Recession (2007-2009), and the ?tepid recovery? (2010-2012). We document that the explanatory power of different factors varies by subperiods, implying that a ...
Working Paper
Sticky Leverage: Comment
We revisit the role of long-term nominal corporate debt for the transmission of inflation shocks in the general equilibrium model of Gomes, Jermann, and Schmid (2016, henceforth GJS). We show that inaccuracies in the model solution and calibration strategy lead GJS to a model equilibrium in which nominal long-term debt is systematically mispriced. As a result, the quantitative importance of corporate leverage in the transmission of inflation shocks to real activity in their framework is 6 times larger than what arises under the rational expectations equilibrium.