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Managing Markets for Toxic Assets

Author

Listed:
  • House, Christopher
  • Masatlioglu, Yusufcan
Abstract
We present a model in which banks trade toxic assets to fund investments. Adverse selection in toxic assets reduces liquidity and investment. Investment is inefficiently low because banks must sell high-quality assets below their "fair" value. We consider whether equity injections and asset purchases improve market outcomes. By allowing banks to fund investments without selling high-quality assets, equity injections reduce the number of high-quality assets traded and further contaminate the interbank market. If equity is directed to firms with the greatest liquidity needs, the contamination effect causes investment to fall. Asset purchase programs often improve liquidity, investment and welfare.

Suggested Citation

  • House, Christopher & Masatlioglu, Yusufcan, 2010. "Managing Markets for Toxic Assets," MPRA Paper 24590, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:24590
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    References listed on IDEAS

    as
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    Cited by:

    1. Baek, Seungjun, 2022. "Optimal policy in lemon markets with flexible information acquisition," Economic Modelling, Elsevier, vol. 106(C).
    2. Camargo, Braz & Lester, Benjamin, 2014. "Trading dynamics in decentralized markets with adverse selection," Journal of Economic Theory, Elsevier, vol. 153(C), pages 534-568.
    3. Kyungmin Kim & Benjamin Lester & Braz Camargo, 2012. "Subsidizing Price Discovery," 2012 Meeting Papers 338, Society for Economic Dynamics.
    4. Borys Grochulski & Yuzhe Zhang, 2015. "Optimal Liquidity Regulation With Shadow Banking," Working Paper 15-12, Federal Reserve Bank of Richmond.
    5. Borys Grochulski & Yuzhe Zhang, 2019. "Optimal liquidity policy with shadow banking," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 68(4), pages 967-1015, November.
    6. Hryckiewicz, Aneta, 2014. "What do we know about the impact of government interventions in the banking sector? An assessment of various bailout programs on bank behavior," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 246-265.
    7. Braz Camargo & Kyungmin Kim & Benjamin Lester, 2016. "Information Spillovers, Gains from Trade, and Interventions in Frozen Markets," The Review of Financial Studies, Society for Financial Studies, vol. 29(5), pages 1291-1329.
    8. Benjamin Lester, 2013. "Breaking the ice: government interventions in frozen markets," Business Review, Federal Reserve Bank of Philadelphia, issue Q4, pages 19-25.
    9. Hryckiewicz, Aneta, 2014. "The problem with government interventions: The wrong banks, inadequate strategies, or ineffective measures?," MPRA Paper 64074, University Library of Munich, Germany.
    10. Feng Dong & Yi Wen, 2017. "Flight to What? — Dissecting Liquidity Shortages in the Financial Crisis," Working Papers 2017-25, Federal Reserve Bank of St. Louis.
    11. Max Bruche & Gerard Llobet, 2010. "Walking Wounded or Living Dead? Making Banks Foreclose Bad Loans," Working Papers wp2010_1003, CEMFI.
    12. Feng Dong & Jianjun Miao & Pengfei Wang, 2018. "The perils of credit booms," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(4), pages 819-861, December.
    13. Dongik Kang, 2023. "System‐Wide Runs and Financial Collapse," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(2-3), pages 531-558, March.

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    More about this item

    Keywords

    Adverse selection; investment; TARP; financial crisis;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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