Part III Financial Institutions [...]... Thailand, CHAPTER 8 An Economic Analysis of Financial Structure South Korea, and Argentina (The stock market declines in Malaysia, Indonesia, and the Philippines, on the other hand, occurred simultaneously with the onset of the crisis.) The Mexican economy was hit by political shocks in 19 94 (specifically, the assassination of the ruling party’s presidential candidate and an uprising in the southern... they work for, the stockholders who own most of the firm’s equity (called the principals) are not the same people as the managers of the firm, who are the agents of the owners This separation of ownership and control involves moral hazard, in that the managers in control (the agents) may act in their own interest rather than in the interest of the stockholder-owners (the principals) because the managers... waves of ethnic violence CHAPTER 8 An Economic Analysis of Financial Structure 199 Summary 1 There are eight basic puzzles about our financial structure The first four emphasize the importance of financial intermediaries and the relative unimportance of securities markets for the financing of corporations; the fifth recognizes that financial markets are among the most heavily regulated sectors of the. .. behind the often-heard lament, “Only the people who don’t need money can borrow it!” Summary So far we have used the concept of adverse selection to explain seven of the eight puzzles about financial structure introduced earlier: The first four emphasize the importance of financial intermediaries and the relative unimportance of securities markets for the financing of corporations; the fifth, that financial. .. capable of playing their traditional financial intermediation role The banking crisis, along with other factors that increased adverse selection and moral hazard problems in the credit markets of Mexico, East Asia, and Argentina, explains the collapse of lending and hence economic activity in the aftermath of the crisis In the aftermath of their crises, Mexico began to recover in 1996, while the crisis countries... point that the banks fail The failure of a large number of banks in a short period of time means that there is a loss of information production in financial markets and hence a direct loss of financial intermediation by the banking sector The decrease in bank lending during a financial crisis also decreases the supply of funds to borrowers, which leads to higher interest rates The outcome of a bank... depositors and avoid a bank panic However, given the loss of bank capital and the need for the government to intervene to prop up the banks, the banks’ ability to lend was nevertheless sharply curtailed As we have seen, a banking crisis of this type hinders the ability of the banks to lend and also makes adverse selection and moral hazard problems worse in financial markets, because banks are less capable of. .. puzzles 3 and 4 Summary Study Guide The presence of asymmetric information in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of those markets Tools to help solve these problems involve the private production and sale of information, government regulation to increase information in financial markets, the importance of collateral and net... foreign currencies, and the sharp increase in the value of these liabilities after the devaluation lead to a further deterioration in the banks’ balance sheets Under these circumstances, the banking system would have collapsed in the absence of a government safety net—as it did in the United States during the Great Depression—but with the assistance of the International Monetary Fund, these countries were... the economy occurred because the collapse in economic activity and the deterioration in the cash flow and balance sheets of both firms and households led to worsening banking crises The problems of firms and households meant that many of them were no longer able to pay off their debts, resulting in substantial losses for the banks Even more problematic for the banks was that they had many short-term liabilities . the financial system and the performance of the aggregate economy, which is the subject of Part V of the book. The economic analysis of financial structure explains how the perform- ance of the. give them grief. The price that a buyer pays must therefore reflect the average quality of the cars in the market, somewhere between the low value of a lemon and the high value of a good car. The. reasons for the importance of financial intermediaries and the relative unimportance of securities mar- kets for the financing of corporations, the prevalence of government regulation, and the importance