B10 Financial policies during the crisis

Question 1

How did the financial crisis affect lending?

Answer 1

New lending was significantly below new lending before the crisis
Explanations:
contraction in loan supply or demand
co-syndication of credit lines with Lehman Brothers reduced a bank’s lending more
better access to deposit financing reduced a bank’s lending less

Question 2

What are financial constraints?

Answer 2

Financially constrained firms are at the point where the supply of capital becomes inelastic
— due to frictions in the supply of capital (e.g. AS)
— internal cost of capital < external cost of capital

Question 3

Show financial constrained and unconstrained firms in two graphs

Answer 3

Question 4

How to measure financial constraints?

Answer 4

Financial constraints are not directly observable

• indirect proxies (e.g. paying dividends)
• observable firms (size, age, or leverage)
• CFO survey (quantity constraint/ price constraint/ difficult access to Letter of Credit (LC))

Question 5

What are real effects of constraints?

Answer 5

Campello et al (2010):

(1) Financially constrained firms planned to cut more investment, technology, marketing, and employment during the crisis
(2) Financially constrained firms were forced to diminish their cash savings and dividend payments.

Question 6

Conclusions

Answer 6

MM: financial intermediaries do not affect credit supply (all +NPV-projects get funding)
crisis: banks faced funding constraints, they reduced lending (driven by supply side effects)
Real effects: financially constrained firms cut investment, technology, marketing, employment, cash savings, dividend payments