Date Added: Feb 2010
This paper studies if borrowers optimally conserve debt capacity to take advantage of investment opportunities due to temporarily low asset prices, when financing is subject to collateral constraints due to limited enforcement. Higher collateralizability may make the contraction more severe. This paper considers the role of financial intermediaries as "Collateralization specialists," who are better able to collateralize claims, and study the dynamics of intermediary capital and spreads between intermediated and direct finance. When intermediary capital is scarce and spreads are high, borrowers who exhaust their debt capacity may be forced to contract by even more.