Credit policy and corporate debt
High debts lead firms to shift their focus to meeting debt obligations rather than pursuing new investment projects, keeping their workers, or maintaining their existing capital stock. High debts also push some firms into bankruptcy, which may result in excessive liquidation and scarring. It is critical to have a clear view of bankruptcy costs as well as the nature of the financial friction facing a firm in order to assess credit policy during the COVID crisis. In particular, in this paper, Brunnermeier and Krishnamurthy distinguish between two cases:
- Policy should inject liquidity into small owner-run enterprises facing liquidity constraints. The bankruptcy costs for these companies are high as a complete liquidation is the likely bankruptcy outcome.
- Policy should facilitate the filing of a Chapter 11 bankruptcy , which allows the firm to restructure its debt, for large corporations for which insolvency is the main issue. The government can achieve this goal by spending resources toward reducing the legal and financial costs of bankruptcy.
Corporate Debt Overhang and Credit Policy
Authors: Markus Brunnermeier, Arvind Krishnamurthy
From: Princeton University, Stanford University
Corporate bankruptcies
In 2019 the non-financial corporate debt to GDP ratio reached a new peak and the highest ever at 47%. As of May 15, 2020 there were 60 companies with assets greater than $100 that filed for bankruptcy under Chapter 11. By extrapolation, argues Edward Altman, the number of firms filing should very conservatively increase to 162 for all of 2020. This compares to 123 in 2019 and an average of 78 over the period 1989-2019. This extrapolated amount of filings would be the third highest in this 40 year period; only 2001(170) and 2009(232) surpassed this number. So far in 2020, 17 of these larger firm filings had assets greater than $1 billion, implying 46 for the entire year, a number surpassed only by 2009 (49). The exceptionally large number of anticipated filings over the next few years has prompted a group of academics to propose to Congress the allocation of additional resources from the federal government to support the bankruptcy courts, and possibly some interim changes in the Bankruptcy Code.
COVID-19 And The Credit Cycle
Author: Edward I. Altman
From: New York University
