Credit Enforcement Cycles

Abstract

Empirical evidence suggests that widespread financial distress, by disrupting enforcement of credit contracts, can be self-propagatory and adversely affect the supply of credit. We propose a unifying theory that models the interplay between enforcement, borrower default decisions, and the provision of credit. The central tenets of our framework are the presence of capacity constrained enforcement and borrower heterogeneity. We show that, despite heterogeneity, borrowers tend to coordinate their default choices, leading to fragility and to credit rationing. Our model provides a rationale for the comovement of enforcement, default rates and credit seen in the data.

Does size matter? Bailouts with large and small banks

“…6 The work by Drozd and Serrano-Padial (2016), which studies credit enforcement, also features heterogeneous agents in an environment with strategic complementarities. Recent work by Kacperczyk, Nosal and Sundaresan (2017) studies the effect of large players in a model of financial market trading and information acquisition.…”

Job Loss, Credit Card Loans, and the College-persistence Decision of US Working Students

“…Existing research shows that demand for credit card loans and other forms of unsecured debt is countercyclical and increases when households become more liquidity constrained (Drozd and Kowalik, 2018;Collins, Edwards, and Schmeiser, 2015;Sullivan, 2008;Bird, Hagstrom, and Wild, 1999). Instead of a bias away from zero, the countercyclical relationship creates a bias toward zero for the interaction between job loss and credit card loans, and we view our estimate of β 2 in Equation 3 as a conservative lower bound of credit card loans' moderating effect on college-persistence rates.…”