Why Capital Structure Matters http://online.wsj.com/article/SB124027187331937083.html Comments welcome.
Interesting insight that increasing the supply of stock can reduce perception of credit risk in certain cases. Very well written article also.
Everything stated in the article is self-evident and well-known. Milken's not exactly shocking anyone these days by pointing out that capital structure actually does matter. He doesn't actually attempt to explain why 'leverage bubbles' arise. Neither is he able to provide any ideas/recipes/suggestions for how to deal with the 'leverage cycle', whether it's through regulation or some other methods. Personally, I am not too impressed.
Just what I was about to say when finished reading the article. I remember a much better written discussion years ago about capital structure in the Harvard Business Review or the Journal of Finance, that eerily sounded similar to this one. I felt reading this article that I'm reading the extract of that paper. Let's see if I can find a link to that paper somewhere. I think the date on it was 1968 or 1969. I guess news has a 30-year life cycle...
Why can't the leverage bubbles be explained by loose credit paired with excessive risk taking fueled by greed? Why is it more complicated than that?
Here are my thoughts on the matter. Your question itself illustrates the most important puzzle. Specifically, you're suggesting two factors create bubbles: 1) loose credit (aka excess leverage); 2) fundamental human nature (optimism/risk seeking/greed, whatever you call it). The most important question to me is whether #1 is, in fact, necessary for the creation of bubbles or is the system inherently unstable and would leverage itself up infinitely even without an initial catalyst. The answer to the question has so many important implications. The other absolutely crucial question, especially in light of all the recent AIG etc noise, is the role of the agency problem in the creation of leverage. Anyways, that's my 2c...