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The Power of the Market and Debt Overhang
Muhammad Mazhar Iqbal, Taraq Waheed Khan
Abstract:
Classical economists claim that market forces function efficiently in commodity, labor and financial markets. However, Marxian and Keynesian economists object to their efficacy in labor market though on different grounds. Regarding loanable funds markets, this paper points out two issues. One is that lenders and borrowers sign a loan agreement without soliciting the consent of loan payers. It leads to debt overhang in government, corporate and household sectors. The other is that lenders judge credit worthiness of borrowers, besides the interest rate which they bid, by their clan, race or religion. Consequently, many loan applicants who belong to socially marginalized groups are excluded from the loanable funds market. Also, startup and small borrowing firms are required by commercial banks to pledge valuable collaterals which they lack and thus become the victim of credit rationing. To control debt overhang, it is therefore recommended that borrowers may be obligated to beseech consent of loan payers before signing a loan contract. Also, credit discrimination against eligible loan applicants belonging to any group may be discouraged and availability of credit to new and small firms may be made more accessible.
Keywords:
Debt financing, equity financing, credit rationing, government debt, corporate debt, household debt
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