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Collateral Crises

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  • Gary Gorton

    (Yale University and NBER (e-mail: gary.gorton@yale.edu))

  • Guillermo Ordonez

    (Yale University (e-mail: guillermo.ordonez@yale.edu)

Abstract

How can a small shock sometimes cause a large crisis when it does not at other times? Financial fragility builds up over time because it is not optimal to always produce costly information about counterparties. Short-term, collateralized, debt (e.g., demand deposits, money market instruments) -private money- is efficient if agents are willing to lend without producing costly information about the value of the collateral backing the debt. But, when the economy relies on this informationally-insensitive debt, information is not renewed over time, generating a credit boom during which firms with low quality collateral start borrowing. During the credit boom output and consumption go up, but there is increased fragility. A small shock can trigger a large change in the information environment; agents suddenly produce information about all collateral and find that much of the collateral is low quality, leading to a decline in output and consumption. A social planner would produce more information than private agents, but would not always want to eliminate fragility.

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 11-E-25.

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Date of creation: Sep 2011
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Handle: RePEc:ime:imedps:11-e-25

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  1. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  2. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  3. William N. Goetzmann & ROGER G. IBBOTSON & LIANG PENG, 2004. "A New Historical Database For The NYSE 1815 To 1925: Performance And Predictability," Yale School of Management Working Papers ysm5, Yale School of Management.
  4. David Andolfatto, 2011. "Undue Diligence," 2011 Meeting Papers 994, Society for Economic Dynamics.
  5. Lagunoff, Roger & Schreft, Stacey L, 1999. "Financial Fragility with Rational And Irrational Exuberance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 531-60, August.
  6. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  7. Federal Reserve Bank of St. Louis & David Andolfatto, 2010. "On the Social Cost of Transparency in Monetary Economies," 2010 Meeting Papers 980, Society for Economic Dynamics.
  8. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises: A New Database," IMF Working Papers 08/224, International Monetary Fund.
  9. Guillermo Ordonez, 2008. "Fragility of Reputation and Clustering in Risk Taking," 2008 Meeting Papers 441, Society for Economic Dynamics.
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Cited by:
  1. Guillermo Ordonez & Christoph Trebesch & Helios Herrera, 2013. "Political Booms, Financial Crises," 2013 Meeting Papers 224, Society for Economic Dynamics.
  2. Farhi, Emmanuel & Tirole, Jean, 2012. "Liquid Bundles," IDEI Working Papers 736, Institut d'Économie Industrielle (IDEI), Toulouse, revised Oct 2013.
  3. Fabrizio Perri & Vincenzo Quadrini, 2011. "International recessions," Staff Report 463, Federal Reserve Bank of Minneapolis.
  4. Itay Goldstein & Assaf Razin, 2013. "Three Branches of Theories of Financial Crises," NBER Working Papers 18670, National Bureau of Economic Research, Inc.
  5. repec:fip:fedreq:y:2011:i:3q:p:209-254:n:vol.97no.3 is not listed on IDEAS
  6. Pablo Kurlat & Laura Veldkamp, 2012. "Should We Regulate Financial Information," Working Papers 12-15, New York University, Leonard N. Stern School of Business, Department of Economics.

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