FIN 3403 Chapter Notes - Chapter 12: Shadow Banking System, Volcker Rule, Troubled Asset Relief Program
11 Apr 2018
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Asymmetric information problems which act as a barrier to efficient allocation of capital. Occurs when information flows in financial markets experience a particularly large disruption (financial frictions increase sharply and financial markets stop functioning) Financial innovation or financial liberalization (promotes financial development and encourages a well-run system that allocates capital efficiently) This can lead to a lending spree called a credit boom. Leads to overly risky lending from lack of screening and monitoring credit risks. Losses on loans increase, value of loans (asset) falls relative to liabilities driving down net worth (capital) of banks/institutions. With less capital, institutions cut back on their lending to borrow-spenders called deleveraging. Lender-savers and potential lenders pull out their funds. Credit freeze, lending boom turns into lending crash. Price of assets (e. g. equity shares and real estate) driven by investor psychology can go well above their fundamental economic values (realistic expectations of assets" future income streams)
