Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning
American Economic Review · 2012 · Volume 102 · Issue 1
Abstract
The paper provides a first analysis of market jump starting and its two-way interaction between mechanism design and participation constraints. The government optimally overpays for the legacy assets and cleans up the market of its weakest assets, through a mixture of buybacks and equity injections, and leaves the firms with the strongest legacy assets to the market. The government reduces adverse selection enough to let the market rebound, but not too much, so as to limit the cost of intervention. The existence of a market imposes no welfare cost. (JEL D82, D83, G01, G31, H81)
Keywords
Asymmetric and Private Information, Search, Learning, Information and Knowledge, Communication, Belief, Financial Crises, Capital Budgeting, Fixed Investment and Inventory Studies, Capacity, Governmental Loans, Loan Guarantees, Credits, and Grants
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