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Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?

19 Pages Posted: 10 May 2010  

Marcus H. Miller

University of Warwick - Department of Economics; Institute for International Economics; Centre for Economic Policy Research (CEPR)

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

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Abstract

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.

Suggested Citation

Miller, Marcus H. and Stiglitz, Joseph E., Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?. The Economic Journal, Vol. 120, Issue 544, pp. 500-518, May 2010. Available at SSRN: https://ssrn.com/abstract=1601553 or http://dx.doi.org/10.1111/j.1468-0297.2010.02357.x

Marcus H. Miller (Contact Author)

University of Warwick - Department of Economics ( email )

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Institute for International Economics

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Centre for Economic Policy Research (CEPR)

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Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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