Private or Public Debt? Effect of Crisis on Financial Intermediation

Abstract

How did the crisis impact financial intermediation? We address this question by studying a unique market segment, viz. foreign private debt issued in the U.S., which grew in size despite the financial crisis. Specifically, foreign private (or Rule 144A) debt issued in the U.S. increased more than five-fold as between pre-crisis (1999-06) and crisis (2007-09) periods compared to public (or Yankee) debt. At the same time, domestic private (144A) debt issuances by U.S. firms remained relatively flat. Using an exhaustive sample of foreign bond issuances in the U.S. from over 65 countries between 1990 and 2013, we examine the effects of the financial crisis on three key corporate decisions viz., debt choice, pricing, and market timing comparing public (Yankee) and private (Rule 144A) debt issues for all foreign firms. We find that Qualified Institutional Buyers (QIBs), the only investors in unregistered 144A bonds, were preferentially funding foreign firms in the 144A market and at better spreads, despite the firms’ high idiosyncratic risks and leverage, and excessive underlying local market volatility. However, we see no such preference in 144A lending to domestic U.S. borrowers. Overall, our findings are consistent with the flight of intermediation in that while many good quality foreign firms began issuing in U.S. due to local capital constraints, QIBs were able to better allocate their scarce capital in favor of quality private debt borrowers.