Abstract
This paper analyzes an economy in which debt overhang occurs simultaneously in the mortgage market and in the market for bank debt. Overhang in one market reinforces overhang in the other. In a closed economy, it is ex post Pareto-efficient to tax households and recapitalize the banks. In an open economy, however, some of the gains are transferred abroad, whereas all the costs are borne by domestic households. Efficient recapitalization programs therefore require global coordination.
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Notes
See Bulow and Shoven (1978), Grossman and Hart (1980), and Gertner and Scharfstein (1991). Contract incompleteness can also be an impediment to renegotiation as argued by Bhattacharya and Faure-Grimaud (2001).
See Tirole (2006) for a complete overview of this literature.
Note that in this case, banks are indifferent between investing and not investing. As projects are indivisible at the microlevel, a fraction of banks invest x=X, while the remaining banks invest nothing. The fraction is such that the equilibrium condition x̄=ȳ1 is satisfied.
(r/(r−δ)−(1−α)(1−β)m̂f(m̂))dm̂=(1−α)(q−r)dx̄−αrdτ and dx̄=Xg(b̂)((1−β)m̂f(m̂)dm̂+rdτ).
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Additional information
*Thomas Philippon is an associate professor of Finance at the Stern School of Business at New York University. The author thanks Mark Aguiar, Pierre-Olivier Gourinchas, Ayhan Kose, and two referees for their comments.