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Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?

  • Marcus Miller
  • Joseph E. Stiglitz

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.

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File URL: http://www.nber.org/papers/w15817.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15817.

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Date of creation: Mar 2010
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Publication status: published as Marcus Miller & Joseph Stiglitz, 2010. "Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?," Economic Journal, Royal Economic Society, vol. 120(544), pages 500-518, 05.
Handle: RePEc:nbr:nberwo:15817
Note: ME
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  1. Gary Gorton, 2008. "The Subprime Panic," Yale School of Management Working Papers amz2504, Yale School of Management.
  2. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  3. Gary Gorton, 2008. "The Panic of 2007," Yale School of Management Working Papers amz2372, Yale School of Management.
  4. Krishnamurthy, Arvind, 2003. "Collateral constraints and the amplification mechanism," Journal of Economic Theory, Elsevier, vol. 111(2), pages 277-292, August.
  5. Prasanna Gai & Sujit Kapadia & Stephen P. Millard & Ander Perez, 2006. "Financial innovation, macroeconomic stability and systemic crises," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  6. Edison, Hali J & Luangaram, Pongsak & Miller, Marcus, 2000. "Asset Bubbles, Leverage and 'Lifeboats': Elements of the East Asian Crisis," Economic Journal, Royal Economic Society, vol. 110(460), pages 309-34, January.
  7. Arvind Krishnamurthy, 2009. "Amplification Mechanisms in Liquidity Crises," NBER Working Papers 15040, National Bureau of Economic Research, Inc.
  8. Gorton, Gary B., 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
  9. Jason Furman & Joseph E. Stiglitz, 1998. "Economic Crises: Evidence and Insights from East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 1-136.
  10. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
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