Knowledge that Transforms

This paper considers the extent to which loan commitments mitigate the problems of information monopolies that arise when the firm contracts with a private lender. Loan commitments in conjunction with short-term debt often provide the firm with superior investment incentives by influencing both the states in which bargaining occurs as well as the outcomes from bargaining. Commitment contracts are particularly valuable when there is a high likelihood that information about the firm will be publicly revealed ex post. We also identify circumstances under which the firm foregoes commitment financing, relying on short-term debt instead. Journal of Economic Literature Classification Numbers G21, G32, D82.

This paper considers the costs and benefits of inflation using a stochastic version of Townsend′s turnpike model in which agents of each type are allowed to remain at a trading post for multiple periods. Numerical results show that moderate rates of inflation can be welfare-improving, but only when private credit markets are extremely limited. More generally, the existence of private credit markets curtails the ability of inflationary policy to do both harm and good. In addition, the welfare consequences of inflation depend on how much information about the economy the government has access to when implementing its policies. Journal of Economic Literature Classification Numbers: D52, E31.

This paper investigates the incentives of a regulator to close depository institutions, recognizing that an institution′s risk taking will be influenced by the regulator′s policy regarding bank closure and that there are opportunity costs in closing banks arising from their intermediation function. The regulator focuses not on the current portfolio of the bank, but on the bank′s future portfolio. Even if the regulator seeks to maximize welfare, the first best is not obtainable because the regulator is unable to credibly commit to certain policies regarding closure. Journal of Economic Literature Classification Numbers: G2, L5, G1.

We argue that since bank loans and publicly traded sub-investment-grade debt, or junk bonds, are close substitutes for one another, the recent failure of Drexel Burnham Lambert created a competitive opportunity for commercial banks. Consistent with this hypothesis, we observe within the commercial banking industry a positive wealth effect associated with Drexel′s failure. The distribution of the wealth effect across commercial banks and Drexel′s investment banking rivals is consistent with the wealth effect being primarily a reflection of market expectations of a return to traditional intermediated funding of sub-investment-grade debt. Journal of Economic Literature Classification Number: G2, Financial Institutions and Services.

We review the contemporary theory of financial intermediation. The focus is on contributions in the past 15 years or so that have advanced our understanding of why financial intermediaries exist, the credit allocation and other services they provide in spot and forward credit markets, the contractual nature and allocational consequences of the claims they issue, and the optimal design of bank regulation. Journal of Economic Literature Classification Numbers: 310, 312, and 314.

This paper analyzes the effects of market value accounting (MVA) on loan maturity. I show that in the presence of asymmetric information MVA introduces a bias into asset valuation against longer-term illiquid assets. This bias increases interest rates for long-maturity loans and induces a shift to short-term self-liquidating loans. With the liquidity production of banks curtailed, borrowers may face "excessive" liquidation. The desirability of MVA applied to loans is thus questionable. Journal of Economic Literature Classification Numbers: G21, G28, M41.

Two-step selection methods are applied to the 1983 Survey of Consumer Finances to examine the extent to which borrowing constraints restrict household access to debt and the manner in which lenders vary debt limits across borrowers. Results indicate that 30% of young families are credit constrained, and that roughly half of these families would hold at least $12,000 (1982 dollars) more debt if borrowing constraints were relaxed. Debt limits increase with income and wealth, and are relaxed for families with a good credit history. In addition, minorities face tighter debt limits and are more likely to be credit constrained than white families. Journal of Economic Literature Classification Numbers: E51, J71, D12.

This paper examines why we have marketmakers (specialists in stock markets, used-car dealers) in some markets and matchmakers (real-estate brokers, employment agencies) in others. Using a bilateral search model, it is shown that when the valuations of the agents are private information, marketmaking might yield higher or lower profits and welfare effects than matchmaking, depending on the efficiency and the cost of search and on the distribution of valuations of the agents. This is in contrast to an earlier result that when the agents' valuations are common knowledge marketmaking yields higher profits and greater welfare effects than matchmaking.