Teleological Investing Part I presents the Guttentag-Herring mechanism as competitive displacement of prudent lenders by aggressive lenders during prolonged expansion, increasing financial vulnerability.

Evidence 1 passage

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  The point here is that in a complex and dynamic economy, all value is relative. Moreover, in such a system the whole economy self-organizes itself into waves of credit expansions/asset inflations and credit contractions/asset deflations by progressively undermining the stability of either regime. The way in which good times can undermine their own financial foundations is ably demonstrated in debt markets by Jack Guttentag and Richard Herring, one of my favorite professors from Wharton, in *Credit Rationing and Financial Disorder.* Let’s say that the economy has just experienced a major recession. The raft of defaults causes lenders to raise their interest rates and tighten their lending standards, only extending credit to their most well capitalized borrowers. As a period of economic expansion begins, bankers remain hesitant, keeping interest rates relatively high and only lending to credit worthy borrowers. However, as the expansion continues the more prudent lenders lose market share to more aggressive lenders who sharply discount or disregard the possibility of another financial disaster.Over time the prudent lenders are driven out of the market place.

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