High leverage leads to widespread default and national crises, study finds.
High leverage can cause widespread default and national crises. When firms have incomplete markets, default and production mismatches occur. Default mechanisms are important for trade to continue. Liquidation costs from default can magnify productivity shocks. Firms may not avoid risky loans that lead to default. Leveraging debt increases the likelihood of defaults in the industry. This leads to lower collateral loans and widespread default.