Working Paper: CEPR ID: DP7469
Authors: Marcus Miller; Joseph E. Stiglitz
Abstract: An iconic model with high leverage and overvalued collateral assets is used to illustrate the amplification mechanism driving asset prices to ?overshoot? equilibrium when an asset bubble bursts - threatening widespread insolvency and what Richard Koo calls a ?balance sheet recession?.Besides interest rates cuts, asset purchases and capital restructuring are key to crisis resolution. The usual bankruptcy procedures for doing this fail to internalise the price effects of asset ?fire-sales? to pay down debts, however. We discuss how official intervention in the form of ?super? Chapter 11 actions can help prevent asset price correction causing widespread economic disruption.
Keywords: asset bubbles; credit constraints; insolvency; interest rates; leverage; restructuring
JEL Codes: E32; G21; G32; G33; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high leverage (G19) | asset bubbles (G19) |
| overpriced collateral assets (G19) | asset bubbles (G19) |
| asset bubbles (G19) | economic collapse (G01) |
| excessive leverage and overpriced collateral assets (F65) | amplification mechanism (C59) |
| amplification mechanism (C59) | asset prices overshoot equilibrium (G19) |
| collapse of an asset bubble (E32) | widespread insolvency (G33) |
| fall in collateral asset prices (G19) | reduced net worth (G32) |
| reduced net worth (G32) | lenders unwilling to extend credit (G21) |
| traditional bankruptcy procedures fail to account for macroeconomic shocks (K35) | excessive liquidation (G33) |
| super chapter 11 actions (G33) | mitigate negative effects of asset price corrections (E44) |
| interest rate cuts alone (E52) | avert economic collapse (F65) |