Chapter

Economic Effects of Financial Fragility

E. Philip Davis

in Debt, Financial Fragility, and Systemic Risk

Published in print October 1995 | ISBN: 9780198233312
Published online November 2003 | e-ISBN: 9780191596124 | DOI: http://dx.doi.org/10.1093/0198233310.003.0005
Economic Effects of Financial Fragility

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Chapters 2 and 3 focused largely on the direct costs of financial fragility, namely increased business failures, household bankruptcies, and mortgage foreclosures. It was noted (Ch. 2, Sect. 3) that the key assumption required for such defaults to be of economic relevance is that there should be positive costs of bankruptcy, i.e. that default does not merely involve a smooth transfer of assets from debtor to creditor. Such costs might include not merely legal costs but also difficulties of firms in keeping personnel, obtaining inventory, costs of portfolio reallocation, costs of disposing of collateral, etc. But it was also noted that financial fragility may have broader economic effects. In the extreme, fragility may lead to systemic risk in the financial system; this relationship, as well as other causes and consequences of systemic risk, is explored in Chs. 5–8. Here we assess some of the wider implications of overindebtedness and default for economic performance, short of the generation of financial instability. In general, these are spillovers or externality effects that are not taken into account by companies or households when selecting their level of gearing in the light of their assets and income, nor by lenders choosing their interest rates on loans. They thus constitute possible grounds for policy intervention.

Keywords: business failure; economic performance; externalities; financial fragility; financial instability; gearing; household bankruptcy; mortgage foreclosures; systemic risk

Chapter.  7056 words. 

Subjects: Financial Markets

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