Collateral Booms and Information Depletion

Abstract We develop a new theory of information production during credit booms. Entrepreneurs need to undertake investment projects, some which enable them divert resources. Lenders can protect themselves from such diversion in two ways: collateralization, and costly screening that generates durable about projects. In equilibrium, the collateralization-screening mix depends on value aggregate collateral. High collateral values make it possible reallocate resources towards productive but they also crowd out screening. This has important dynamic implications. During booms driven by high (e.g. real estate booms), economic activity expands economy’s stock existing projects gets depleted. As result, collateral-driven end deep crises slow recoveries: when end, is constrained both lack takes time rebuild. provide empirical support for mechanism using US firm-level data.