Managing Markets for Toxic Assets

House, Christopher and Masatlioglu, Yusufcan (2010): Managing Markets for Toxic Assets.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Adverse selection; investment; TARP; financial crisis
• Subjects: D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E22 - Investment ; Capital ; Intangible Capital ; Capacity; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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