Knowledge that Transforms

We argue that since bank loans and publicly traded sub-investment-grade debt, or junk bonds, are close substitutes for one another, the recent failure of Drexel Burnham Lambert created a competitive opportunity for commercial banks. Consistent with this hypothesis, we observe within the commercial banking industry a positive wealth effect associated with Drexel′s failure. The distribution of the wealth effect across commercial banks and Drexel′s investment banking rivals is consistent with the wealth effect being primarily a reflection of market expectations of a return to traditional intermediated funding of sub-investment-grade debt. Journal of Economic Literature Classification Number: G2, Financial Institutions and Services.

We review the contemporary theory of financial intermediation. The focus is on contributions in the past 15 years or so that have advanced our understanding of why financial intermediaries exist, the credit allocation and other services they provide in spot and forward credit markets, the contractual nature and allocational consequences of the claims they issue, and the optimal design of bank regulation. Journal of Economic Literature Classification Numbers: 310, 312, and 314.

This paper analyzes the effects of market value accounting (MVA) on loan maturity. I show that in the presence of asymmetric information MVA introduces a bias into asset valuation against longer-term illiquid assets. This bias increases interest rates for long-maturity loans and induces a shift to short-term self-liquidating loans. With the liquidity production of banks curtailed, borrowers may face "excessive" liquidation. The desirability of MVA applied to loans is thus questionable. Journal of Economic Literature Classification Numbers: G21, G28, M41.

Two-step selection methods are applied to the 1983 Survey of Consumer Finances to examine the extent to which borrowing constraints restrict household access to debt and the manner in which lenders vary debt limits across borrowers. Results indicate that 30% of young families are credit constrained, and that roughly half of these families would hold at least $12,000 (1982 dollars) more debt if borrowing constraints were relaxed. Debt limits increase with income and wealth, and are relaxed for families with a good credit history. In addition, minorities face tighter debt limits and are more likely to be credit constrained than white families. Journal of Economic Literature Classification Numbers: E51, J71, D12.