Financial Crisis Essay

Financial Crisis Essay-79
How did it come to pass that in 2008 our nation was forced to choose between two stark and painful alternatives — either risk the collapse of our financial system and economy, or commit trillions of taxpayer dollars to rescue major corporations and our financial markets, as millions of Americans still lost their jobs, their savings, and their homes?The Commission concluded that this crisis was avoidable.

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However, national governments through bank bailouts acted quickly to save these institutions from collapse.

Nevertheless, the stock markets around the globe fall drastically.

The government is often tempted to strategically disclose its superior knowledge to influence management of financial risk by a firm.

To capture this, I develop a static model in which the government with private information sends a cheap-talk message to the firm before assuming its risk taking.

Moreover, real estate pricing was severely affected by the crisis.

Financial Crisis Essay

As a result most people were left unemployed while the lucky ones who retained their jobs experienced drastic fall in income.The value of the asset is the firm's private information, which results in inefficient trading of the asset due to standard adverse selection.Although the adverse selection problem creates a scope for government intervention, accepting a bailout can signal the toxicity of the asset, which worsens the adverse selection for the firm in the subsequent trading of its asset.In the first chapter, jointly written with Yeon-Koo Che and Chongwoo Choe, we focus on observations during the recent financial crisis that financially distressed firms may be reluctant to accept government bailouts for fear that it may signal the weakness of their balance sheets and inhibit future financing.To capture such bailout stigma, we develop a dynamic model in which a firm must finance projects by selling legacy assets.In this model, bailing out a distressed firm influences the belief about the state held by another firm in the later period, yielding two conflicting effects.First, the bailout indicates an increased chance that the economy is in crisis, which discourages the later firm from risk taking.However, the firm rationally infers this strategic disclosure, and therefore, may assume excessive risk taking no matter what messages does it receive from the government.Consequently, an informative equilibrium may worsen moral hazard compared to the babbling equilibrium.We further explore an optimal design of a bailout program both in offer terms and formats and show that a secret bailout that conceals the identity of its recipient can mitigate the stigma and can implement the (constrained) efficient outcome.The second chapter is motivated by a situation in which when a firm is financially distressed, it is uncertain whether the distress stems from an unfolding economic crisis or excessive risk-taking by the firm.

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