1. Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009

2. Previous literature: “Constrained borrower” view Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998) Wealth constrained agency

3. Previous literature: “Constrained borrower” view Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998) Injurious liquidation Diamond and Dybvig (1983), Schleifer and Vishny (1992), Hölmstrom and Tirole (1997), Wealth constrained agency

4. Previous literature: “Constrained borrower” view Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998) Injurious liquidation Diamond and Dybvig (1983), Schleifer and Vishny (1992), Hölmstrom and Tirole (1997), Wealth constrained agency Key idea: Shocks propagate by affecting borrower collateral

5. This paper: “Constrained lender” view 1.Specialized lenders channel saving to investment – “Brealey-Myers managers”

6. This paper: “Constrained lender” view 1.Specialized lenders channel saving to investment – “Brealey-Myers managers” 2.Lenders form long-term contractual relationships with projects, subject to agency costs

7. This paper: “Constrained lender” view 1.Specialized lenders channel saving to investment – “Brealey-Myers managers” 2.Lenders form long-term contractual relationships with projects, subject to agency costs 3.Averse shocks break up projects, lenders take time to find new projects

8. This paper: “Constrained lender” view 1.Specialized lenders channel saving to investment – “Brealey-Myers managers” 2.Lenders form long-term contractual relationships with projects, subject to agency costs 3.Averse shocks break up projects, lenders take time to find new projects 4.Household asset reallocation creates negative feedback

9. This paper: “Constrained lender” view 1.Specialized lenders channel saving to investment – “Brealey-Myers managers” 2.Lenders form long-term contractual relationships with projects, subject to agency costs 3.Averse shocks break up projects, lenders take time to find new projects 4.Household asset reallocation creates negative feedback Den Haan, Ramey and Watson, “Liquidity Flows and Fragility of Business Enterprises,” JME, 2003

10. Results 1.Agency costs  shocks propagated through lender- project relationships

11. Results 1.Agency costs  shocks propagated through lender- project relationships 2.Household responses amplify propagation

12. Results 1.Agency costs  shocks propagated through lender- project relationships 2.Household responses amplify propagation 3.Propagation is greater when shocks are more persistent

13. Results 1.Agency costs  shocks propagated through lender- project relationships 2.Household responses amplify propagation 3.Propagation is greater when shocks are more persistent 4.Asset market feedbacks  shocks propagate across sectors

14. Broader contribution: New approach to modeling saving and investment

15. Broader contribution: New approach to modeling saving and investment Traditional model: Capital = accumulated output

16. Broader contribution: New approach to modeling saving and investment Traditional model: Capital = accumulated output Lender expertise model: Capital = accumulated managerial knowledge

17. Model Unit mass of households Unit mass of specialized lenders Periods t = 1,2,3,…

18. Model Unit mass of households Unit mass of specialized lenders Periods t = 1,2,3,… In each period, a lender is either matched with a project or searching for a new project

19. Model Unit mass of households Unit mass of specialized lenders Periods t = 1,2,3,… In each period, a lender is either matched with a project or searching for a new project

20. Project surplus

23. Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000) Agency cost

24. Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000) Agency cost

25. Project search

27. Equilibrium conditions

30. Asset market

31. Driving process

32. Numerical example

43. Extensions 1.Lender effort

44. Extensions 1.Lender effort 2.Physical capital

45. Extensions 1.Lender effort 2.Physical capital 3.Long-term contracting, liquidity hoarding

46. Extensions 1.Lender effort 2.Physical capital 3.Long-term contracting, liquidity hoarding 4.Countercyclical policy – “bailouts”