Abstract: This paper studies the efficiency of financial intermediation through securitization in a
model with heterogeneous investment projects and asymmetric information about the quality of securitized assets. Issuers
of securitized assets can signal asset quality by retaining part of the risk. I find that signaling contributes to the
variation in the degree of asymmetric information over the business cycle, which creates the documented growth asymmetry
in the cycle. In particular, in the boom stage of the business cycle, signaling is inefficient and lower-quality assets
accumulate on the balance sheets of financial intermediaries. This implies a deeper drop in output in a subsequent recession
proportional to the length of the preceding boom.
Fragility of Resale Markets for Securitized Assets and Policy of Asset Purchases
Abstract: Markets for securitized assets were characterized by high liquidity prior to the recent financial crisis and by a sudden market dry-up at the onset of the crisis. A general
equilibrium model with heterogeneous investment opportunities and information frictions predicts that, in boom periods or mild recessions, the degree of adverse selection in resale markets for securitized
assets is limited because of the reputation-based guarantees by asset originators. This supports investment and output. However, in a deep recession, characterized by high dispersion of asset qualities,
there is a sudden surge in adverse selection due to an economy-wide default on reputation-based guarantees, which persistently depresses the output in the economy. Government policy of asset purchases
limits the negative effects of adverse selection on the real economy, but may create a negative moral hazard problem.
In or Out: Do Bail-In Bonds Really Decrease Bailouts? (with Kinda Hachem)
Abstract: Bail-in bonds have gained a lot of attention among bank regulators. These bonds supposedly raise the hurdle for a government
bailout by converting into loss-absorbing capital once the issuing bank runs into trouble. We argue that banks can short-circuit bail-in
requirements by offering investors off-balance-sheet insurance against conversion. The bond itself appears as a bail-in bond on the issuer's
balance sheet while the insurance is booked off balance sheet until the bond converts. The government can deter insurance provision by imposing
penalties when insurance is discovered, but these penalties may not be credible. We find conditions for an equilibrium in which insurance against
conversion is provided by banks and bailed out by the government rather than penalized upon discovery. We also present new empirical evidence in support of our model.
Abstract:What are the macroeconomic and policy implications of government-backed mortgage default insurance?
A New-Keynesian DSGE model with heterogeneous lenders and borrowers and information frictions is
constructed and calibrated to answer this question. The model endogenizes the moral hazard implications of
government-backed mortgage insurance and shows that insurance results in weaker lending standards, higher
mortgage origination to low-quality borrowers, more frequent mortgage defaults and greater housing market exuberance.
But the model also identifies a positive effect of mortgage insurance in reducing the adverse selection in
securitization markets, which results in cheaper and more stable mortgage funding. For this benefit of mortgage
insurance to outweigh its moral hazard costs, mortgage insurance needs to be complemented with sufficiently
strict minimum lending standards.
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