Macroeconomic Implications of Debt Contracts
Sunday, Jan. 6, 2019 1:00 PM - 3:00 PM
- Chair: Yueran Ma, University of Chicago
Mortgage Design and Housing Market
AbstractHow can mortgages be redesigned to reduce housing market volatility, consumption volatility, and default? How does mortgage design interact with monetary policy? We answer these questions using a quantitative equilibrium life cycle model with aggregate shocks, long-term mortgages, and an equilibrium housing market, focusing on designs that index payments to monetary policy. Designs that raise mortgage payments in booms and lower them in recessions do better than designs with fixed mortgage payments. The welfare benefits are quantitatively substantial: ARMs improve household welfare relative to FRMs by the equivalent of 0.83 percent of annual consumption under a monetary regime in which the central bank lowers real interest rates in a bust. Among designs that reduce payments in a bust, we show that those that front-load the payment reductions and concentrate them in recessions outperform designs that spread payment reductions over the life of the mortgage. Front-loading alleviates household liquidity constraints in states where they are most binding, reducing default and stimulating housing demand by new homeowners. To isolate this channel, we compare an FRM with a built-in option to be converted to an ARM with an FRM with an option to be refinanced at the prevailing FRM rate. Under these two contracts, the present value of a lender’s loan falls by roughly an equal amount, as these contracts primarily differ in the timing of expected repayments. The FRM that can be converted to an ARM, which front loads payment reductions, improves household welfare by four times as much.
Anatomy of Corporate Borrowing Constraints
AbstractMacro-finance analyses commonly link firms’ borrowing constraints to the liquidation value of physical collateral. For US non-financial firms, we show that 20% of debt by value is collateralized by physical assets (“asset-based lending” in creditor parlance), whereas 80% is based predominantly on cash flows from firms’ operations (“cash flow-based lending”). A standard borrowing constraint restricts total debt as a function of cash flows measured using operating earnings (“earnings-based borrowing constraints”). These features shape firm outcomes on the margin: first, cash flows in the form of operating earnings can directly relax borrowing constraints; second, firms are less vulnerable to collateral damage from asset price declines, and fire sale amplifications may be mitigated.
Firm Debt Covenants and the Macroeconomy
AbstractInterest coverage covenants, which set a minimum ratio of earnings to interest payments, are among the most popular provisions in firm debt contracts. For affected firms, the amount of additional debt that can be issued without violating these covenants is highly sensitive to interest rates. At the macroeconomic level, these covenants therefore provide a potential source of transmission from interest rates into firm borrowing and investment. This paper investigates this transmission channel empirically, and develops a macroeconomic framework to characterize its properties in general equilibrium. Importantly, most firms that have interest coverage covenants also face a maximum on the ratio of debt to earnings. Simultaneously imposing these limits implies a novel source of state-dependence: when interest rates are high, interest coverage limits are tighter, amplifying the influence of interest rate changes and monetary policy, while when rates are low, debt-to-earnings covenants dominate and transmission is weaker.
University of Pennsylvania
New York University
University of Chicago
- E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
- G0 - General