Managing Markets for Toxic
نویسندگان
چکیده
We present a model in which banks trade toxic assets to raise funds for investment. The toxic assets generate an adverse selection problem and, as a consequence, the interbank asset market provides insufficient liquidity to finance investment. Investment is inefficiently low because acquiring funding requires banks to sell high-quality assets for less than their " fair " value. We analyze whether equity injections or asset purchases improve market outcomes. Equity injections reduce liquidity and may be counterproductive as a policy for increasing investment. Paradoxically, if it is directed to firms with the greatest liquidity needs, an equity injection will reduce investment further. In contrast, asset purchase programs, like the Public-Private Investment Program, often have favorable impacts on liquidity, investment and welfare.
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