Discussion of "The Transmission of Quasi-Sovereign Default Risk: Evidence from Puerto Rico"

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Discussion of “The Transmission of Quasi-Sovereign Default Risk: Evidence from Puerto Rico” by Chari, Leary and Phan Marı́a Pı́a Olivero, PhD GIC Conference - LeBow College of Business Drexel University

February 28th , 2020

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Summary of Results

The Government Demand Channel: An increase in default risk disproportionately affects employment in industries that are more dependent on demand from the Puerto Rican government

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Take-Aways

Novel way to isolate the macro effects of an exogenous shock, i.e. bankruptcy and non-bailout of Detroit → Puerto Rico

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Take-Aways

Novel way to isolate the macro effects of an exogenous shock, i.e. bankruptcy and non-bailout of Detroit → Puerto Rico New government demand channel 6= well known financial dependence channel

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Take-Aways

Novel way to isolate the macro effects of an exogenous shock, i.e. bankruptcy and non-bailout of Detroit → Puerto Rico New government demand channel 6= well known financial dependence channel Interesting case!! default risk can be disentangled from currency risk

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

The Instrument?

Michigan vs Puerto Rico GDP (in millions of current $) 600000.0

120000

500000.0

100000

400000.0

80000

300000.0

60000

200000.0

40000

100000.0

20000

0.0

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

0

GSP_MI

GDP_PR

The Transmission of Quasi-Sovereign Default Risk

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Publicly-Traded vs Smaller Firms in Manufacturing 1.5

1

.5

0

-.5

-1 310

320 FINDEP_ASM

The Transmission of Quasi-Sovereign Default Risk

NAICS

330 FINDEP_Compustat

340

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

5 Most Financially-Dependent Industries

(1) (2) (3) (4) (5)

Compustat Chemicals Beverages and tobacco Computer and electronics Furniture and related products Miscellaneous

The Transmission of Quasi-Sovereign Default Risk

ASM Computer and electronics Paper Nonmetallic minerals Plastics and rubber Wood products

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

5 Least Financially-Dependent Industries

(1) (2) (3) (4) (5)

Compustat Apparel Printing and related support activities Leather and allied products Wood products Food

The Transmission of Quasi-Sovereign Default Risk

ASM Leather and allied products Furniture and related products Apparel Textiles Petroleum and coal

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Lags in the Econometric Specification

The transmission channel government default → government demand → employment in “government-intensive� industries Lags?

In D’Erasmo, Moscoso-Boedo and Olivero (forthcoming) ∆lit = Îątk + β1 Ei2001 + β2 F Ci2001 + β3 Xit−3 + it

The Transmission of Quasi-Sovereign Default Risk

Two-Step Approach

Summary

Puerto Rico-Michigan Link Financial Dependence Onvariables the Econometric The controls at the bank level are intended to account for other that can Specification impact the

banks’ availability of loanable funds. As such, the vector Xit−3 includes banks’ liquidity and leverage, the level of loans to the private non-financial sector, and profitability as measured by banks’ net income.17 We include the most stringent fixed effect such that we are able keep the variables of interest in the regression.18 We measure liquidity using the ratio of liquid assets to total assets and bank leverage using the inverse of the equity to asset ratio. Our measure of bank size is standard and given by the value of total assets. Table 2 presents the results.

Lags in the Econometric Specification Bank-Level Effects of Sovereign Debt and Foreign Currency Exposure Dep. Variable Government Exposure Sov. Debt Exposure (Ei,2001 )

∆`it -0.845** (0.047)

-0.923** (0.030)

-0.985** (0.018)

-0.721* (0.095) -0.298 (0.118)

-0.747* (0.084) -0.495** (0.014)

-0.847** (0.045) -0.386* (0.051)

1.353*** (0.000) -0.622*** (0.000)

1.553*** (0.000) -0.755*** (0.000) 0.0501** (0.024)

1.239*** (0.000) -0.633*** (0.000)

1.440*** (0.000) -0.824*** (0.000) 0.0692*** (0.003)

yes 2003-2005 3,220 0.029

yes 2003-2005 3,220 0.030

1.393*** (0.000) -0.431*** (0.001) 0.0219 (0.314) 2.387*** (0.000) yes 2003-2005 3,220 0.077

yes 2003-2005 3,220 0.029

yes 2003-2005 3,220 0.032

1.306*** (0.000) -0.487*** (0.000) 0.0370 (0.109) 2.371*** (0.000) yes 2003-2005 3,220 0.078

FC Exposure (F Ci,2001 ) Bank Characteristics Liquidityi,t−3 Leveragei,t−3 (log) Real Assetsi,t−3 Net Incomei,t−3 Bank Type×Time FE Period N. of Observations R-squared

Note: “Sov. Debt Exposure” refers to the ratio of domestic government bonds to total assets in 2001. “FC Exposure” refers to the ratio of non-deposit foreign currency liabilities to total assets in 2001. p-values in parentheses. *p<0.10, **p<0.05, ***p<0.01.

The estimated coefficients indicate that exposure to sovereign debt prior to the time of default and devaluation has a negative and significant effect on the availability of credit postdefault.19 This prima facie evidence suggests that the supply channel of default is statistically 17 18

Appendix A-3 presents several robustness checks that involve including additional controls.

Results do not change if we include only time fixed effects, only bank-type fixed effects, or time and

The Transmission of Quasi-Sovereign Risk bank-type fixedDefault effects separately.

Two-Step Approach

Summary

Puerto Rico-Michigan Link

Financial Dependence

On the Econometric Specification

Two-Step Approach

Diff-in-Diff vs Two-Step Approach á la Kashyap and Stein (2000) Exploit the panel nature of the data in two separate steps Relaxing the linearity assumption regarding the effects of default-risk on employment logEit ∂ 2 logEit ∂GOVi ∂P ostDetroitt

= α + βGOVi × P ostDetroitt + ......... = β̂

logEi

=

α + βGOVi + .........

β̂

=

δP ostDetroitt

∂ logEit ∂GOVi ∂P ostDetroitt

=

∂ β̂ = δ̂ ∂P ostDetroitt

2

The Transmission of Quasi-Sovereign Default Risk

∀t