Participation in assets as a solution to the debt crises - Реферат

Participation in assets as a solution to the debt crises Najafov Salman Baku State University Abstract Last global financial crisis, as well as liquidity trap in Japan, the theory of debt deflation, the financial fragility hypothesis, the theory of balance sheet recession testifies imperfections of financial relations based on debt financing. It forces to reconsider principles of functioning of the financial system and search new approaches to solving debt crises. In article some theories of debt crises are shown, and it is argued that the participation in assets that provides coupling of debts with assets will allow solving of debt crises. Key words: debt crisis, participation in asset, debt deflation, the financial fragility hypothesis, balance sheet recession JEL classification. G01 1. Introduction The Global financial and economic crisis in 2007 and a liquidity crisis of the worlds leading banks force us to reconsider the debt relations. Credit boom accompanied by rising debt payments, could not continue persistently. Debt servicing was possible only with high incomes or assets value of the debtor, and as soon as the growth of income or assets stopped, the debtors have faced problems in servicing their debts: in spite of the decline in income and assets value of debt borrowers’ debt during the crisis did not reduce. As a result, the debtors faced decoupling of debts from assets. According to Minsky decoupling between firms’ debt and assets, or the debt crisis caused by the cyclical nature of economic development: at the beginning of the boom phase firms finance their investment mostly at their own expense, and the role of loans is low. At this stage the companies’ incomes allow them to repay debts. With the growth of the economy firms are actively moving to external financing of capital investments. However, there comes a situation when income of many companies reduces, but their debts remain fixed. As a result, firms faced decoupling of debts from assets and their ability to service its debt decreases. Minsky to diminish financial instability has proposed to constrain the banking financing of capital assets and limitation on the liability structure of business. Another case of decoupling of debts from assets is liquidity trap in Japan. Richard Koo argues that deep recession in the Japanese economy is connected with balance sheet recessions - when bubble burst wealth of private sector declined but debts remained unchanged. As a result large number of private companies faced defaults leading to the credit crisis. Credit crunch leads to decrease in deposit that reduces the interest rate on deposits to close to zero level. Similar process occurs in the United States too, where the mortgage crisis and the decline in property prices causes a decrease in value of borrowers’ assets in comparison with debts. It leads to a decrease in lending activity which reduces interest rates. The decoupling of firms’ debt from asset is also causes the debt deflation. There are several channels debt crisis leads to deflation. According to Fisher if over-indebtedness exists, this leads to debt liquidation. But debt liquidation leads to contraction of deposit that slowing down velocity of circulation causes deflation. Minsky argues that if as a result of decline in income borrowers are faced difficulties in repay debts they are forced to sell assets. Selling of assets reduces asset prices, and losses from decline in asset values in comparison with debts reduce consumption and investment through a wealth effect that leads to deflation. According to Bernanke debt deflation is caused by credit squeeze that decreases aggregate demand. In article a new approach of solution to debt crises is argued, and to avoid decoupling of the debts from asset the transition from financial relations based on the debt to the model based on the participation in assets is suggested. 2. Study of the debt crises A significant contribution to the study of the debt crises is introduced by Minsky, who developed the hypothesis of financial fragility. Minsky debt crisis connects with the cyclical nature of economic development. So, at the beginning of the boom phase of the business cycle firms finance their investment projects mostly at their own expense, the role of loans is low. This is due to the fact that at this stage the growth of investment activity is still moderate, the credit risks are still high. The companies’ incomes allow them to repay the interest on the loan and principal. With the growth of the economy and favorable forecasts firms are beginning to step up investment, credit risk also reduce. As a result, firms are actively moving to external financing of capital investments. However, the income may not grow continuously. After a while there comes a situation when income of many companies reduces, but their debts remain fixed. As a result, firms ability to service its debt decreases, number of defaults on loans starts to increase. To avoid