University of Michigan
Department of Economics
Ann Arbor MI, 48109-1220
NBER Working Papers and Publications
|July 2010||Managing Markets for Toxic Assets|
with Christopher L. House: w16145
We present a model in which banks trade toxic assets to raise funds for investment. The toxic assets generate an adverse selection problem and, as a consequence, the interbank asset market provides insufficient liquidity to finance investment. While the best investments are fully funded, socially efficient projects with modest payoffs are not. Investment is inefficiently low because acquiring funding requires banks to sell high-quality assets for less than their "fair" value. We then consider whether equity injections and asset purchases can improve market outcomes. Equity injections do not improve liquidity and may be counterproductive as a policy for increasing investment. By allowing banks to fund investments without having to sell high-quality assets, equity injections reduce the numbe...
Published: Christopher L. House & Yusufcan Masatlioglu, 2015. "Managing markets for toxic assets," Journal of Monetary Economics, vol 70, pages 84-99. citation courtesy of