IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Liquidity, Efficiency and Bank Bailouts

  • Gary Gorton
  • Lixin Huang

Why do governments bailout banking systems in distress? We argue that the government can efficiently provide liquidity. We present a general equilibrium model in which not all assets can be used to purchase all other assets at every date. At some dates agents want to sell projects or securities. The only buyers are agents who have previously opportunistically invested in otherwise dominated assets because only these ( liquid') assets can be used to purchase the projects or securities. The market price of the projects or securities sold depends on the supply of liquidity, which is determined in general equilibrium. The supply of liquidity is not perfectly elastic so asset prices can deviate from efficient market' prices, that is, the conditional expectation of the asset payoff. While private liquidity provision is socially beneficial since it allows valuable reallocations, it is also socially costly since liquidity suppliers could have made more efficient investments ex ante. As a result, there is a potential role for the government to supply liquidity by issuing government securities, backed by tax revenue. Government bailouts of banking systems are an example of such public liquidity provision.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.nber.org/papers/w9158.pdf
Download Restriction: no

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9158.

as
in new window

Length:
Date of creation: Sep 2002
Date of revision:
Publication status: published as Gorton, Gary and Lixin Huang. "Liquidity, Efficiency, And Bank Bailouts," American Economic Review, 2004, v94(3,Jun), 455-483.
Handle: RePEc:nbr:nberwo:9158
Note: CF
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Web page: http://www.nber.org
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Mari Pangestu & Manggi Habir, 2002. "The Boom, Bust and Restructuring of Indonesian Banks," IMF Working Papers 02/66, International Monetary Fund.
  2. Sanford J. Grossman, 1989. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," NBER Working Papers 2357, National Bureau of Economic Research, Inc.
  3. Kane, Edward J. & Yu, Min-Teh, 1996. "Opportunity cost of capital forbearance during the final years of the FSLIC mess," The Quarterly Review of Economics and Finance, Elsevier, vol. 36(3), pages 271-290.
  4. Gary Gorton & Andrew Winton, 2002. "Financial Intermediation," NBER Working Papers 8928, National Bureau of Economic Research, Inc.
  5. Klingebiel, Daniela, 2000. "The use of asset management companies in the resolution of banking crises - cross-country experience," Policy Research Working Paper Series 2284, The World Bank.
  6. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Lummer, Scott L. & McConnell, John J., 1989. "Further evidence on the bank lending process and the capital-market response to bank loan agreements," Journal of Financial Economics, Elsevier, vol. 25(1), pages 99-122, November.
  8. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Bank Bailouts and Aggregate Liquidity," American Economic Review, American Economic Association, vol. 92(2), pages 38-41, May.
  9. 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.
  10. Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
  11. International Monetary Fund, 1999. "Recapitalizing Banks with Public Funds; Selected Issues," IMF Working Papers 99/139, International Monetary Fund.
  12. Honohan, Patrick, 2001. "Recapitalizing banking systems : implications for incentives and fiscal and monetary policy," Policy Research Working Paper Series 2540, The World Bank.
  13. International Monetary Fund, 2002. "Banking Crises and Bank Resolution; Experiences in Some Transition Economies," IMF Working Papers 02/56, International Monetary Fund.
  14. Ceyla Pazarbasioglu & Claudia Helene Dziobek, 1997. "Lessons From Systemic Bank Restructuring; A Survey of 24 Countries," IMF Working Papers 97/161, International Monetary Fund.
  15. Mark R. Stone, 2002. "Corporate Sector Restructuring; The Role of Government in Times of Crisis," IMF Economic Issues 31, International Monetary Fund.
  16. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  17. Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," NBER Working Papers 9102, National Bureau of Economic Research, Inc.
  18. Hopenhayn, Hugo A. & Werner, Ingrid M., 1996. "Information, Liquidity, and Asset Trading in a Random Matching Game," Journal of Economic Theory, Elsevier, vol. 68(2), pages 349-379, February.
  19. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  20. Douglas W. Diamond, 2001. "Should banks be capitalized?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 71-96.
  21. De Luna-Martinez, J., 2000. "Management and Resolution of Banking Crises. Lessons from the Republic of Korea and Mexico," World Bank - Discussion Papers 413, World Bank.
  22. Gorton, Gary & Kahn, James, 2000. "The Design of Bank Loan Contracts," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 331-64.
  23. Charles W. Calomiris, 1994. "Is the discount window necessary? a Penn Central perspective," Review, Federal Reserve Bank of St. Louis, issue May, pages 31-55.
  24. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  25. Hiroshi Nakaso, 1999. "Recent banking sector reforms in Japan," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 1-7.
  26. Andrea L. Eisfeldt, 2004. "Endogenous Liquidity in Asset Markets," Journal of Finance, American Finance Association, vol. 59(1), pages 1-30, 02.
  27. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  28. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  29. Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-56, October.
  30. De la Torre, Augusto, 2000. "Resolving bank failures in Argentina - recent developments and issues," Policy Research Working Paper Series 2295, The World Bank.
  31. D. Woo, 2000. "Two Approaches to Resolving Nonperforming Assets During Financial Crises," IMF Working Papers 00/33, International Monetary Fund.
  32. Walker F. Todd, 1992. "History of and rationales for the Reconstruction Finance Corporation," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 22-35.
  33. James Daniel, 1997. "Fiscal Aspects of Bank Restructuring," IMF Working Papers 97/52, International Monetary Fund.
  34. Guonan Ma & Ben S.C. Fung, 2002. "China's asset management corporations," BIS Working Papers 115, Bank for International Settlements.
  35. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  36. Leslie Teo & Charles Enoch & Carl-Johan Lindgren & Tomás J. T. Baliño & Anne Marie Gulde & Marc Quintyn, 2000. "Financial Sector Crisis and Restructuring; Lessons from Asia," IMF Occasional Papers 188, International Monetary Fund.
  37. Edward J. Kane, 1987. "DANGERS OF CAPITAL FORBEARANCE: THE CASE OF THE FSLIC AND "ZOMBIE" S&Ls," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 77-83, 01.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:9158. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.