The Costs of Curbing Speculation : Evidence from the Establishment of 'Investment Grade'

In 1936, regulators unexpectedly banned banks from purchasing “speculative” bonds. This announcement caused a sudden persistent rise in speculative bond yields, even comparing securities within the same firm. In contrast to prior evidence during credit booms, I document a substantial decline in equity values for firms reliant on speculative debt financing. Regulations to curb bank speculation are provoked by economic distress, but my findings suggest recoveries may be costly periods for such restrictions. Costs are also exacerbated by reliance on rating agencies. Firms reduce debt to “game” ratings, causing slower investment and asset growth in subsequent years