Can the cure kill the patient? Corporate credit interventions and debt overhang

Abstract

Interventions in corporate credit markets were a major innovation in the policy response to the 2020 recession. This paper develops and estimates a model to quantify their impact on borrowing and investment. Even during downturns, credit interventions can be a bad policy idea, because they exacerbate debt overhang and depress investment in the long run. However, if the downturn is accompanied by financial market disruptions, they initially help forestall inefficient liquidations. These short term benefits quantitatively dominate the long run overhang costs. Additionally, constraining shareholder distributions, and targeting high-leverage firms substantially increases the bang for the buck of credit interventions.