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Friday, Jan. 7, 2022
10:00 AM - 12:00 PM (EST)
American Economic Association
Leverage Risk and Investment: The Case of Gold Clauses in the 1930s
We study the impact of the 1933 abrogation of gold clauses on the slow recovery of corporate
investment following the Great Depression. Legal challenges to the constitutionality of the
abrogation of gold clauses exposed many firms to the possibility of a 69% increase in required
payments to bondholders. We show that public firms with higher exposure to this risk
reduced their investment in 1933 and 1934. For these firms, investment recovers quickly
following the Supreme Court’s 1935 decision to uphold abrogating gold clauses. In the cross-section
of firms, decreases in investment over 1933 and 1934 coincide with an increase in
equity payouts. Our estimates imply that the risk of higher financial leverage accounts for
about one-third of the decline in aggregate investment by public firms over 1933 and 1934.
This channel complements existing explanations of the slow recovery based on bank credit
supply which public firms did not rely on.
Leverage Limits in Good and Bad Times
How do leverage limits affect lending? We examine a regulatory change to the business development company (BDC) lending sector, which allowed lenders to double their regulatory leverage constraint. Exploiting the staggered timing of approvals, we show that this allowed firms to slowly adjust loan portfolios and increase leverage, but suddenly increase the unrealized losses reported on their loans. These patterns around approvals suggest that the slackness of regulatory constraints has important effects on lenders’ incentives to accurately assess fair value. In addition, we explore how the pandemic differentially affected BDCs that were close to or far from their leverage limits. Our results shed light on an important lending sector for small businesses, which has grown dramatically since the Great Recession.
We develop a simple model of relationship lending where lenders have an incentive to evergreen loans by offering better terms to less productive and more indebted firms. We detect such lending distortions using loan-level supervisory data for the United States. Low-capitalized banks systematically distort their risk assessments of firms to window-dress their balance sheets and extend relatively more credit to underreported borrowers. Consistent with our theoretical predictions, these effects are driven by larger outstanding loans and low-productivity firms. We incorporate the theoretical mechanism into a dynamic heterogeneous-firm model to show that evergreening can affect aggregate outcomes, resulting in lower interest rates, higher levels of debt, and lower aggregate productivity.
Cross-Subsidization of Bad Credits in a Lending Crisis
Using a unique dataset we study the corporate-loan pricing decisions of a major Greek bank in the years surrounding the recent Greek financial crisis. The unique aspect of the dataset is that besides the loan interest rates, firm characteristics, loan characteristics, etc. we can also observe the breakeven rate that is provided to the account managers by the bank’s loan pricing department. This allows a straightforward measurement of the extent to which the loan’s breakeven rate is passed through to the customer. We document positive and significant markups to the low breakeven-rate borrowers (“good borrowers”) and zero or even negative markups to the high breakeven-rate borrowers (“bad borrowers”). Pass-through is sluggish in the time-series and asymmetric across good and bad borrowers. The discrepancy between interest rates and breakeven costs does not predict changes in the borrower’s future financial conditions, suggesting that interest rates do not embed additional information that is not available to the bank’s pricing department.
G2 - Financial Institutions and Services