Showing papers on "Debt published in 2020"

Financial Heterogeneity and the Investment Channel of Monetary Policy

Abstract: We study the role of financial frictions and firm heterogeneity in determining the investment channel of monetary policy. Empirically, we find that firms with low default risk—those with low debt burdens and high “distance to default”— are the most responsive to monetary shocks. We interpret these findings using a heterogeneous firm New Keynesian model with default risk. In our model, low‐risk firms are more responsive to monetary shocks because they face a flatter marginal cost curve for financing investment. The aggregate effect of monetary policy may therefore depend on the distribution of default risk, which varies over time.

Anatomy of Corporate Borrowing Constraints

Abstract: Macro-finance analyses commonly link firms’ borrowing constraints to the liquidation value of physical assets. For U.S. nonfinancial firms, we show that 20% of debt by value is based on such 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 amplification may be mitigated. Taken together, our findings point to new venues for modeling firms’ borrowing constraints in macro-finance studies.

Attacking the DeFi Ecosystem with Flash Loans for Fun and Profit

Abstract: Credit allows a lender to loan out surplus capital to a borrower. In the traditional economy, credit bears the risk that the borrower may default on its debt, the lender hence requires an upfront collateral from the borrower, plus interest fee payments. Due to the atomicity of blockchain transactions, lenders can offer flash loans, i.e. loans that are only valid within one transaction and must be repaid by the end of that transaction. This concept has lead to a number of interesting attack possibilities, some of which have been exploited recently (February 2020). This paper is the first to explore the implication of flash loans for the nascent decentralized finance (DeFi) ecosystem. We analyze two existing attacks vectors with significant ROIs (beyond 500k%), and then go on to formulate finding flash loan-based attack parameters as an optimization problem over the state of the underlying Ethereum blockchain as well as the state of the DeFi ecosystem. Specifically, we show how two previously executed attacks can be "boosted" to result in a profit of 829.5k USD and 1.1M USD, respectively, which is a boost of 2.37x and 1.73x, respectively.

How Valuable is Financial Flexibility when Revenue Stops? Evidence from the COVID-19 Crisis

Abstract: The COVID-19 shock creates a sudden temporary sharp shortfall in revenue for firms. We expect firms with greater financial flexibility to be better able to fund themselves in the presence of a revenue shortfall and to benefit less from the news concerning policy responses to the crisis on March 24. We show that firms with less financial flexibility experience worse stock returns until March 23 and benefit more from the news on March 24. Specifically, we find that firms with high financial flexibility experience a stock price drop lower by 26% or 9.7 percentage points than those with low financial flexibility. Similar results hold for CDS spreads. Had firms not made payouts over the last three years, the stock price drop for a firm with an average payout over assets ratio would have been lower by less than 2 percentage points. If firms in the top quartile of payouts over assets for the last three years did not have payouts over that period, they could, on average, have repaid all their long-term debt and their stock price drop would have been lower by 5.1 percentage points. Existing measures of financial constraints are not helpful in explaining the reaction of firms to the shock.

Global Waves of Debt : Causes and Consequences

Abstract: ADVANCE EDITION OF BOOK EXPECTED IN 2020. The global economy has experienced four waves of debt accumulation over the past fifty years. The first three debt waves ended with financial crises in many emerging and developing economies. The latest, since 2010, has already witnessed the largest, fastest and most broad-based increase in debt in these economies. Their total debt has risen by 54 percentage points of GDP to a historic peak of almost 170 percent of GDP in 2018. Current low interest rates mitigate some of the risks associated with high debt. However, emerging and developing economies are also confronted by weak growth prospects, mounting vulnerabilities, and elevated global risks. A menu of policy options is available to reduce the likelihood of the current debt wave ending in crisis and, if crises were to take place, alleviate their impact. To shed light on the implications of the rapid debt accumulation, Global Waves of Debt presents the first in-depth analysis of the main features of global and national debt accumulation episodes, analyzes the linkages between debt accumulation and financial crises, and draws policy lessons.

Monetary Policy when Households have Debt: New Evidence on the Transmission Mechanism

Abstract: In response to an unanticipated change in interest rates, households with mortgage debt adjust their expenditure signicantly, especially on durable goods, renters react to a lesser extent and outright home-owners do not react at all. All housing tenure groups experience a signicant change in disposable income (over and above the direct impact on mortgage repayments). The response of house prices is sizable, driving a signicant adjustment in loanto-income ratios but little change in loan-to-value ratios. A simple collateral constraint model augmented with durable goods and a renting decision generates predictions consistent with these novel empirical ndings and suggests that heterogeneity in housing debt positions plays an important role in the transmission of monetary policy.

Local Crowding Out in China

Abstract: In China, between 2006 and 2013 local public debt crowded out the investment of private firms by tightening their funding constraints, while leaving state-owned firms'investment unaffected. We establish this result using a purpose-built dataset for Chinese local public debt. Private firms invest less in cities with more public debt, the reduction in investment being larger for firms located farther from banks in other cities or more dependent on external funding. Moreover, in cities where public debt is high, private firms'investment is more sensitive to internal cash flow, also when cash-flow sensitivity is estimated jointly with the probability of being credit-constrained.

Corporatization in the public sector : explaining the growth of local government companies.

Abstract: The creation of companies by local governments to provide public services—referred to as “corporatization”—is an example of systemic public entrepreneurship that is popular across the world. To build knowledge of the antecedents of public sector entrepreneurship, the authors investigate the factors that lead local governments to create companies for public service delivery. Using zero‐inflated negative binomial regressions to analyze secondary data from 150 major English local governments for 2010–16, the authors find that governments with higher levels of grant dependence and debt dependence are more involved in the creation and operation of companies, as are larger governments. Further analysis reveals that very low and very high managerial capabilities are strongly associated with more involvement in profit‐making companies, while local government involvement in companies is more prevalent in deprived areas. At the same time, government ownership of companies is more common in areas with high economic output.

Liquidity vs. Wealth in Household Debt Obligations: Evidence from Housing Policy in the Great Recession

Abstract: We exploit variation in mortgage modifications to disentangle the impact of reducing long-term obligations with no change in short-term payments ("wealth"), and reducing short-term payments with no change in long-term obligations ("liquidity") Using regression discontinuity and difference-in-differences research designs with administrative data measuring default and consumption, we find that principal reductions that increase wealth without affecting liquidity have no effect, while maturity extensions that increase only liquidity have large effects This suggests that liquidity drives default and consumption decisions for borrowers in our sample and that distressed debt restructurings can be redesigned with substantial gains to borrowers, lenders, and taxpayers

Financial Crises, Dollarization, and Lending of Last Resort in Open Economies

Abstract: Foreign currency debt is considered a source of financial instability in emerging markets. We propose a theory in which liability dollarization arises from an insurance motive of domestic savers. Since financial crises are associated to depreciations, savers ask for a risk premium when saving in local currency. This force makes domestic currency debt expensive, and incentivizes borrowers to issue foreign currency debt. Providing ex post support to borrowers can alleviate the effect of the crisis on savers' income, lowering their demand for insurance, and, surprisingly, it can reduce ex ante incentives to borrow in foreign currency.

Deadly Debt Crises: COVID-19 in Emerging Markets

Abstract: The coronavirus pandemic has severely impacted emerging markets by generating a large death toll, deep recessions, and a wave of sovereign defaults. We study this compound health, economic, and debt crisis and its mitigation by integrating epidemiological dynamics into a sovereign default model. The epidemic leads to an urgent need for social distancing measures, a large drop in economic activity, and a protracted debt crisis. The presence of default risk restricts fiscal space and presents emerging markets with a trade-off between mitigation of the pandemic and fiscal distress. A quantitative analysis of our model accounts well for the dynamics of deaths, social distance measures, and sovereign spreads in Latin America. In the model, the welfare cost of the pandemic is higher because of financial market frictions: about a third of the cost comes from default risk, compared with a version of the model with perfect financial markets. We study debt relief programs through counterfactuals and find a compelling case for their implementation, as they deliver large social gains.

Can the Covid Bailouts Save the Economy

Abstract: The covid-19 crisis has led to a sharp deterioration in firm and bank balance sheets. The government has responded with a massive intervention in corporate credit markets. We study equilibrium dynamics of macroeconomic quantities and prices, and how they are affected by government policy. The interventions prevent a much deeper crisis by reducing corporate bankruptcies by about half and short-circuiting the doom loop between corporate and financial sector fragility. The additional fiscal cost is zero since program spending replaces what would otherwise have been spent on intermediary bailouts. The model predicts rising interest rates on government debt and slow debt pay-down. We analyze an alternative intervention that targets aid to firms at risk of bankruptcy. While this policy prevents more bankruptcies and has lower fiscal cost, it only enjoys marginally higher welfare. Finally, we study longer-run consequences for firm leverage and intermediary health when pandemics become the new normal.

The pandemic and economic policy uncertainty

Abstract: The events that occurred after the worldwide diffusion of COVID-19 provide a real-life example of how uncertainty can severely affect the global economy This paper reviews literature on the negative impacts of the economic policy uncertainty index (EPU) as developed by Baker et al , The Quarterly Journal of Economics, 2016, 131, 1593?1636 on individuals, businesses, governments, and economies at the local and international levels This reveals that a high EPU is associated with adverse effects on households, corporations, and governments, which tend to delay many financial decisions under high uncertainty, which leads to lower consumption, fewer issuances of debt, fewer investments, and higher unemployment The effects of political and regulatory uncertainty also extend to the commodity markets, such as the adverse effects on both oil and gasoline markets, and can potentially create adverse impacts on the crypto-currency market and its potential growth We demonstrate that governmental uncertainty also affects financial, housing, and equity markets;debt issuances;and the entire economy This underscores the importance of considering EPU as a risk factor The association with several components of the global economy reflects not only the EPU index's critical influence, but also the importance of risk management Our results lead us to consider the gravity of economic policy uncertainty and call for innovation across different sectors to mitigate its adverse effects

Financing the Belt and Road Initiative (BRI): research agendas beyond the “debt-trap” discourse

Abstract: By way of introduction to the four papers that follow, we chart some key parameters of debate about finance and the Belt and Road Initiative (BRI). In particular, we argue that the rise of discours...

When Investor Incentives and Consumer Interests Diverge: Private Equity in Higher Education

Abstract: This paper studies how private equity buyouts create value in higher education, a sector with opaque product quality and intense government subsidy. With novel data on 88 private equity deals involving 994 schools, we show that buyouts lead to higher tuition and per-student debt. Exploiting loan limit increases, we find that private equity-owned schools better capture government aid. After buyouts, we observe lower education inputs, graduation rates, loan repayment rates, and earnings among graduates. Neither school selection nor student body changes fully explain the results. The results indicate that in a subsidized industry maximizing value may not improve consumer outcomes.

In Sickness and in Debt: The COVID-19 Impact on Sovereign Credit Risk

Abstract: The COVID-19 pandemic provides a unique setting in which to evaluate the importance of a country's fiscal capacity in explaining the relation between economic growth shocks and sovereign default risk For a sample of 30 developed countries, we find a positive and significant sensitivity of sovereign default risk to the intensity of the virus' spread for fiscally constrained governments Supporting the fiscal channel, we confirm the results for Eurozone countries and US states, for which monetary policy can be held constant Our analysis suggests that financial markets penalize sovereigns with low fiscal space, thereby impairing their resilience to external shocks

Debt and Financial Vulnerability on the Verge of Retirement

Abstract: We analyze older individuals’ debt and financial vulnerability using data from the Health and Retirement Study (HRS) and the National Financial Capability Study (NFCS). Specifically, in the HRS we examine three different cohorts (individuals age 56–61) in 1992, 2004, and 2010 to evaluate cross-cohort changes in debt over time. We also use two waves of the NFCS (2012 and 2015) to gain additional insights into debt management and older individuals’ capacity to shield themselves against shocks. We show that recent cohorts have taken on more debt and face more financial insecurity, mostly due to having purchased more expensive homes with smaller down payments.

Globalisation in the time of COVID-19: repositioning Africa to meet the immediate and remote challenges.

Abstract: The COVID-19 pandemic has ushered in a new climate of uncertainty which is fuelling protectionism and playing into nationalist narratives Globalisation is under significant threat as governments scramble to reduce their vulnerability to the virus by limiting global trade and flows of people With the imposition of border closures and strict migration measures, there have been major disruptions in Africa's global supply chains with adverse impacts on employment and poverty The African economies overly reliant on single export-orientated industries, such as oil and gas, are expected to be severely hit This situation is further aggravated by tumbling oil prices and a lowered global demand for African non-oil products The agricultural sector, which should buffer these shocks, is also being affected by the enforcement of lockdowns which threaten people's livelihoods and food security Lockdowns may not be the answer in Africa and the issue of public health pandemic response will need to be addressed by enacting context-specific policies which should be implemented in a humane way In addressing the socioeconomic impact of COVID-19 on African nations, we argue that governments should prioritize social protection programmes to provide people with resources to maintain economic productivity while limiting job losses International funders are committing assistance to Africa for this purpose, but generally as loans (adding to debt burdens) rather than as grants G20 agreement so suspend debt payments for a year will help, but is insufficient to fiscal need Maintaining cross-border trade and cooperation to continue generating public revenues is desirable New strategies for diversifying African economies and limiting their dependence on external funding by promoting trade with a more regionalised (continental) focus as promoted by the African Continental Free Trade Agreement, while not without limitations, should be explored While it is premature to judge the final economic and death toll of COVID-19, African leaders' response to the pandemic, and the support they receive from wealthier nations, will determine its eventual outcomes

Economic consequences of high public debt: evidence from three large scale DSGE models

Abstract: The paper reviews the economic risks associated with regimes of high public debt through DSGE model simulations. The large public debt build-up following the 2009 global financial and economic crisis acted as a shock absorber for output, while in the recent and more severe COVID19-crisis, an increase in public debt is even more justified given the nature of the crisis. Yet, once the crisis is over and the recovery firmly sets in, keeping debt at high levels over the medium term is a source of vulnerability in itself. Moreover, in the euro area, where monetary policy focuses on the area-wide aggregate, countries with high levels of indebtedness are poorly equipped to withstand future asymmetric shocks. Using three large scale DSGE models, the simulation results suggest that high-debt economies (1) can lose more output in a crisis, (2) may spend more time at the zero-lower bound, (3) are more heavily affected by spillover effects, (4) face a crowding out of private debt in the short and long run, (5) have less scope for counter-cyclical fiscal policy and (6) are adversely affected in terms of potential (long-term) output, with a significant impairment in case of large sovereign risk premia reaction and use of most distortionary type of taxation to finance the additional debt burden in the future. Going forward, reforms at national level, together with currently planned reforms at the EU level, need to be timely implemented to ensure both risk reduction and risk sharing and to enable high debt economies address their vulnerabilities. JEL Classification: E62, H63, O40, E43

The efficacy of sustainability reporting towards cost of debt and equity reduction.

Abstract: This paper empirically investigates the impact of overall sustainability reporting as well as its components (economic, environmental, and social sustainability reporting) on the cost of debt and equity capital for Malaysian oil and gas companies. The data was collected from 41 publicly listed oil and gas companies in Malaysia for the period from 2008 to 2017. Qualitative information was gathered for sustainability reporting and then converted into quantitative form by assigning weights according to the extent of reporting. The cost of capital information was sourced through Thomson Reuters Datastream. Panel data analysis was employed using generalized least square (GLS) random effects regression to examine the relationship between sustainability reporting and cost of capital. Firm reputation, size, and profitability were included as control variables. The findings indicate that overall sustainability reporting and one component, economic sustainability reporting, reduce both cost of debt and cost of equity. However, environmental sustainability reporting reduces only the cost of debt but does not reduce the cost of equity. Social sustainability reporting shows no effect on the cost of debt or equity. The findings of this paper should be useful for regulators, legislators, shareholders, creditors, and practitioners in pursuing sustainability practices that not only improve economic and environmental performance but also enhance overall performance by reducing the cost of capital. The results of the paper highlight that companies investing in sustainability can generate positive value through the enhancement of reputational capital. This study is the first to empirically investigate the relationship between overall sustainability reporting, including its three components, and the cost of both debt and equity capital.

Emerging market debt and the COVID-19 pandemic: A time–frequency analysis of spreads and total returns dynamics

Abstract: We apply wavelet analyses to study the impact of COVID-19 pandemic on the performance of emerging market bonds, in both investment grade and high yield ranges of creditworthiness Our results show varying level of coherence ranging from low, medium and high between the Coronavirus Media Coverage index and the price moves of the emerging market USD-denominated debt We attribute the intervals of low coherence levels to the diversification potential during a systemic pandemic such as COVID-19 of investments in bonds issued by developing economies We document differences in patterns exhibited by various indices describing behaviour of option-adjusted spreads and total returns as a function of credit quality of issuers form emerging market economies We report well-defined zones of the regime switching between the lead and lag roles of the emerging market bonds vis-a-vis the media coverage

Bank Risk Dynamics and Distance to Default

Abstract: We adapt structural models of default risk to take into account the special nature of bank assets. The usual assumption of log-normally distributed asset values is not appropriate for banks. Typical bank assets are risky debt claims, which implies that they embed a short put option on the borrowers’ assets, leading to a concave payoff. This has important consequences for banks’ risk dynamics and distance to default estimation. Due to the payoff non-linearity, bank asset volatility rises following negative shocks to borrower asset values. As a result, standard structural models in which the asset volatility is assumed to be constant can severely understate banks’ default risk in good times when asset values are high. Bank equity payoffs resemble a mezzanine claim rather than a call option. Bank equity return volatility is therefore much more sensitive to big negative shocks to asset values than in standard structural models.

Attacking the DeFi Ecosystem with Flash Loans for Fun and Profit

Abstract: Credit allows a lender to loan out surplus capital to a borrower. In the traditional economy, credit bears the risk that the borrower may default on its debt, the lender hence requires upfront collateral from the borrower, plus interest fee payments. Due to the atomicity of blockchain transactions, lenders can offer flash loans, i.e., loans that are only valid within one transaction and must be repaid by the end of that transaction. This concept has lead to a number of interesting attack possibilities, some of which were exploited in February 2020.