In addition to having run the Reserve Bank of India, knowing much about American farmland in the 1920's and a fine veg cutlet, he also has a comfy endowed chair at the University of Chicago's Booth School of Business.
Here, via the Chicago Booth Review he talks debt, August 27. His interlocutor, Hal Weitzman, is an Adjunct Associate Professor of Behavioral Science and executive director for intellectual capital at Chicago Booth (oh, and also editor-in-chief of the CBR and host of The Chicago Booth Review podcast):
Almost all companies take loans—some secured by assets they own, and others unsecured. But is that distinction meaningful in the real world? Chicago Booth’s Raghuram G. Rajan talks about his research into corporate debt. In the past century, the amount of unsecured debt has soared. What’s the significance of that, and is it really unsecured?
Raghuram Rajan: So asset values matter. It's just that they're in the background. So if you have a boom and bust, even in a developed country, you will have fluctuations in your ability to borrow and you'll have really bad consequences if you've over-borrowed and asset values plummet.
Hal Weitzman: Almost all companies borrow money. Some of it's secured by assets they own, other debts, unsecured. But is that distinction meaningful in the real world? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman, and today I'm talking with Chicago Booth's Raghuram Rajan about his research into corporate debt. In the past century, the amount of unsecured debt has soared. What's the significance of that and is it really unsecured? Welcome to the Chicago Booth Review Podcast.
Raghuram Rajan: Thanks for having me.
Hal Weitzman: We're here to talk about your research on debt and all companies have debt, and broadly there are two kinds of debt, right? There's secured debt and there's unsecured debt. What's the difference? Remind us between the two.
Raghuram Rajan: Secured debt is when I attach an asset to the debt and say, "If I default on my debt, you can take the asset." So for example, when you lease a car, basically the debt is secured by the car and if you stop car payments, somebody comes and takes your car away. Similarly, for firms, a lot of secured debt against property plant and equipment, you have debt against receivables. So that's secured debt. Unsecured debt is when you have an obligation to pay, but there's no asset that the lender can seize. Of course, essentially all debt is against all assets. So while there's no specific asset they can seize if you don't pay, they basically can put you in bankruptcy, in which case the assets are really moved over to the creditor.
Hal Weitzman: Okay. And so that's kind of the conceit of this research, is that even unsecured debt is somehow secured. It's implicitly asset-backed.
Raghuram Rajan: Exactly.
Hal Weitzman: So if as you say, the reality is even if you have unsecured debt, at some point I'll be able to claim something back, does that mean there's not much of a difference practically between secured debt and unsecured debt?
Raghuram Rajan: Well, there is in the sense that if I secure my debt today, it gives me less flexibility. Obviously, I can't use the same asset to get more borrowing from somebody else down the line because I've already pledged it to somebody. So it gives me less financial flexibility. It may also give me less real flexibility in the sense that sometimes in the course of business, I want to sell this asset, I don't need it as much, but if it's pledged to a lender, I have to get their permission. Can I substitute this other asset? So it complicates matters.
It complicates the running of your business. It gives you less flexibility. It may also subject you to hold up if your lender basically said, "No, I want no other asset." Then you're stuck with this asset because you've already pledged it and you can't substitute it with something else. So if firms had a choice, they would prefer unsecured debt rather than secured debt as a form of issuance.
Hal Weitzman: Right. And so for those who are not in this world, that begs the question, why can't they get it? Is it just because people don't want to lend against not implicit assets rather than explicit ones?
Raghuram Rajan: Exactly. I mean, go back to Merchant of Venice.
Hal Weitzman: Sure....
....MUCH MORE
Previous visits with Professor Rajan:
Raghuram Rajan: "We Should Be on the Alert for More Problems"
Long time readers may remember Professor Rajan from such hits as:
Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg CutletOkay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.
Also:
- Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
- Raghuram Rajan: "Disruption, Concentration, and the New Economy"
- "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
- Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)
- Former RBI Governor Raghuram G. Rajan On Development Economics: India Has An Opportunity To Do Something Never Before Attempted
- Raghuram Rajan: "Breaking the Mould: Reimagining India’s Economic Future"
- Raghuram G. Rajan: "Central Bank's Independence At Risk Of Being Dominated By Financial Assets"
