For years, scholars have questioned the efficiency of secured debt, many suggesting that it transfers uncompensated risk to unsecured creditors. However, prior writing on the value of secured debt ignores the distinction between the use and the availability of secured credit. As a result, previous models of secured debt erroneously assume that a debtor that can borrow on an unsecured basis will nevertheless borrow on a secured basis to reduce interest cost. This Article combines theory, experience, and empirical tests to show that earlier models do not reflect the expected behavior of an economically rational debtor. These models fail to recognize that the most important form of secured debt, new money credit secured by collateral, tends to create value for unsecured creditors as well as for the debtor. A debtor that can borrow unsecured has an economic incentive not to prematurely encumber its assets because doing so gives away value in an amount-which the Article calls Theta-that exceeds any interest cost saving. Perhaps the most significant component of this value is the increased liquidity that secured credit affords. The Article also shows that this increased liquidity does not generally keep alive debtors that should be allowed to fail, because lenders will be reluctant to extend credit, even on a secured basis, to debtors that are likely to go bankrupt. Furthermore, troubled debtors will themselves be reluctant to incur secured debt unless they can thereby avoid bankruptcy. Secured credit is therefore usually extended in these circumstances only where the liquidity would help the debtor regain viability. Accordingly, unsecured creditors themselves should want debtors to have access to secured credit.

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