Victoria Ivacina
Victoria Iwashina
Chair of the Department of Finance, Harvard Business School
Since the 2007-2008 global financial crisis, household debt has been seen as the main driver of the financial crisis. This has prompted macroprudential policies in many countries to focus on tightening borrowing restrictions in the household sector. There is plenty of evidence that household debt played a key role in America's boom-bust cycle in the early 21st century. Internationally, the increase in household debt is seen as predictable of business cycle recessions and financial crises, as well as the slow recovery after such crises.
However, the macroeconomic impact of corporate debt is inconclusive and has received less attention. While there is firm-level evidence that over-leverage hurts corporate investment and employment, international data show that corporate debt dynamics do not generate boom-bust growth cycles, and have only a weak predictive power for subsequent GDP growth. Similarly, Jordà et al. found that it was only in countries where corporate insolvencies were particularly inefficient that the post-financial crisis corporate credit boom left a lasting mark on the macroeconomy.
In a recent paper, we re-examine the role of corporate debt in macroeconomic volatility using a large historical cross-country panel dataset on credit markets in the Global Credit Project. This dataset is unique in that it allows us to break down corporate credit by industry. The dataset covers a total of 115 developed and emerging economies from 1940 to 2014. We have also constructed a new time series of credit from non-bank financial institutions, which was missing in previous work. The dataset is unprecedented in breadth and scope, overlapping with 87 systemic financial crises.
Using this more granular data set, we find that corporate debt plays a crucial role in the boom-bust cycle, financial crisis, and sluggish macroeconomic recovery. In the three years leading up to the financial crisis, corporate debt accounted for about two-thirds of total credit growth. In the aftermath of the crisis, the ensuing credit crunch was entirely focused on credit to businesses, as was the vast majority of non-performing loans. In terms of predictive power, we find that the expansion of corporate debt is just as important, if not more important, in predicting crises than household debt, and it can also predict the depth of a post-crisis recession.
To understand the intrinsic link between corporate debt and crisis, we took advantage of industry differences in the data and the fact that industries rely differently on different types of collateral. Consistent with the available data linking the mortgage value of real estate to corporate behavior, we find that lending to firms that rely on real estate as collateral (e.g., construction firms) is relatively strongly associated with the crisis. Over the past three years, a single standard deviation increase in real estate-collateralized corporate credit relative to GDP has increased the probability of a financial crisis by 3.7 percentage points over the next three years. We found similar results in the credit sector of the non-bank financial sector, which, as we found, tends to lend to non-financial firms. These findings suggest that corporate debt expansion contains important information about the risk of future economic collapse.
The sectoral differences in our data also allow us to examine whether the distressed credit boom was a period of "dysfunctional" growth in some sectors. We find that during credit expansion, the dispersion of credit across sectors increases systematically. This typical fact suggests that there is heterogeneous easing and tightening of financial constraints across all sectors, reflecting the role of heterogeneous credit constraints recorded in firm-level data. The dispersion index we propose can predict crises outside of the scale of credit expansion, and the change in the credit-to-GDP ratio is a measure of the scale of credit expansion. In our benchmark specification, each standard deviation increase in dispersion increases the probability of predicting a crisis by 3.6 percentage points. Our explanation is that even when the two credit booms were of the same size, the disproportionate growth of credit flows to certain sectors portends increased risk-taking in some sectors, with a potential impact on the overall stability of the financial system.
We also used local forecasts to examine whether corporate debt affects the sluggish post-crisis recovery. In particular, we looked at how real GDP per capita moves depending on the type of credit available before the recession. Once again, we find that corporate debt is very important to macroeconomic dynamics. Corporate debt not only makes financial crises more likely, but also prolongs the recovery period from recessions that usually follow, a result that is particularly pronounced for corporate debt secured by real estate.
We link this sluggish recovery to deteriorating asset quality. Using newly collected data on non-performing loans across industries, we find that three-quarters of total non-performing loans on banks' balance sheets after the crisis came from businesses rather than households. We also found that corporate defaults in sectors that use real estate collateral are particularly likely to spike during a banking crisis. Finally, we find that the boom in corporate debt is particularly predictive of an increase in total non-performing loans after a crisis, especially when there are real estate collaterals, while we find that the effect of household debt expansion is even weaker.
Original link:
https://cepr.org/voxeu/columns/corporate-debt-and-financial-crises
(Chang Changsheng/excerpt)
The above views and remarks do not represent the position of this platform.
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