Credit contagion and the amplification of the Crisis of 2007-2009

Abstract

The bankruptcy of Lehman Brothers in September 2008 caused a major global financial market disruption as many of its counterparties were adversely affected. It is puzzling why they were not better prepared for the situation. In this paper we generalize the setting and examine credit contagion through supplier-customer relationship. We find that suppliers are more prone to customer default than the other way around. This effect is stronger during crisis period. We analyze operating performance as well as the trade credit channels. Balance sheet contagion is more pronounced for industrial firms than financial firms, as the latter have less unique (customer specific) products. Our findings can shed light on how the U.S. subprime mortgage market decline transmitted into a global credit crisis.