Which of the following are not examples of a vicious cycle of deleveraging? Explain.
a. Your university decides to sell several commercial buildings in the middle of town in order to upgrade buildings on campus.
b. A company decides to sell its large an valuable art collection because other asset prices on its balance sheet have fallen below a critical level, forcing creditors to call in their loans to the company because of provisions written into the original loan contract.
c. A company decides to issue more stock in orders t voluntarily pay off some of its debt.
d. A shadow bank must sell its holdings of corporate bonds because falling asset prices have led to a default on the terms of its loan with some creditors.
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To determine which of the options are not examples of a vicious cycle of deleveraging, we need to first understand what a vicious cycle of deleveraging is.
A vicious cycle of deleveraging refers to a situation in which a reduction in debt leads to a downward spiral, causing further economic contraction and asset price declines. It usually occurs when individuals, businesses, or financial institutions with high levels of debt are forced to sell off assets to repay their debts, which in turn leads to a decline in asset prices, making it even more difficult for them to repay their debts. This creates a negative feedback loop that reinforces the deleveraging process.
Now, let's analyze the options:
a. Your university decides to sell several commercial buildings in the middle of town in order to upgrade buildings on campus.
This option does not seem to involve a vicious cycle of deleveraging. It is a strategic decision by the university to sell some assets (commercial buildings) to raise funds for upgrading buildings on campus. While it involves selling assets, it does not necessarily indicate a debt problem or a downward spiral.
b. A company decides to sell its large and valuable art collection because other asset prices on its balance sheet have fallen below a critical level, forcing creditors to call in their loans to the company due to provisions written into the original loan contract.
This option does exhibit a vicious cycle of deleveraging. The company's decision to sell its assets (art collection) is driven by the falling asset prices, which puts the company in a difficult financial position. The creditors calling in their loans due to the provisions in the loan contract further exacerbate the situation, creating a negative loop.
c. A company decides to issue more stock in order to voluntarily pay off some of its debt.
This option does not represent a vicious cycle of deleveraging. Instead, it shows a proactive approach by the company to reduce its debt burden voluntarily. By issuing more stock, the company is essentially raising capital to pay off its debt, which does not involve a negative feedback loop caused by falling asset prices or forced asset sales.
d. A shadow bank must sell its holdings of corporate bonds because falling asset prices have led to a default on the terms of its loan with some creditors.
This option does exhibit a vicious cycle of deleveraging. The shadow bank selling its holdings of corporate bonds is a direct consequence of falling asset prices, which has led to a default on its loan terms with creditors. This forced selling of assets due to financial distress reinforces the downward spiral and characterizes a vicious cycle of deleveraging.
In conclusion, the options (a) and (c) are not examples of a vicious cycle of deleveraging, while options (b) and (d) illustrate such a cycle.