23%20Financial%20Crisis%20and%20the%20Economy,%20Part%201

23 Financial Cri - Agenda 1 Asymmetric Information and Financial Crises Financial Crises and the Economy Part 1 2 Dynamics of Financial Crises 3

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1 23-1 Financial Crises and the Economy, Part 1 23-2 Agenda 1. Asymmetric Information and Financial Crises 2. Dynamics of Financial Crises 3. The Great Depression 23-3 Asymmetric Information, Financial Crises Asymmetric information creates two basic types of problems in the financial system. 1. Adverse selection —in which lenders must select from a pool of bad ( adverse ) credit risks because the most undesirable potential borrowers are the most active in seeking out a loan, and 2. Moral hazard —when there is risk ( hazard ) that the borrower has better information than the lender about whether it will engage in activities that are undesirable ( immoral ) from the point of view of the lender. 23-4 Asymmetric Information, Financial Crises Agency theory provides an explanation for how asymmetric information can generate: 1. Adverse selection problems, and 2. Moral hazard problems and provides a basis for the definition of a financial crisis .
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2 23-5 Asymmetric Information, Financial Crises •A financial crisis occurs when: 1. A disruption in the financial system 2. Increases asymmetric information which 3. Prevents the financial system from channeling funds efficiently from savers-lenders to borrowers-spenders. 23-6 Dynamics of Financial Crises Financial crises progress in stages: 1. The initiation of the financial crisis leads to a 2. Banking crisis which may precipitate a 3. Debt deflation . 23-7 Dynamics of Financial Crises Financial crisis generally begin because of: 1. Mismanagement of financial innovation , and/or financial liberalization , and/or 2. An asset price boom and bust , and/or 3. An increase in uncertainty . 23-8 Initiation of the Financial Crisis 1. Mismanagement of innovation/liberalization: Financial innovation occurs when an economy introduces new types of loans and/or new types of other financial products. Financial innovation can be mismanaged if there is not an accurate and full understanding of the risks associated with the new financial products.
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3 23-9 Initiation of the Financial Crisis 1. Mismanagement of innovation/liberalization:
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This note was uploaded on 09/05/2011 for the course ECON 100B taught by Professor Wood during the Spring '08 term at University of California, Berkeley.

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23 Financial Cri - Agenda 1 Asymmetric Information and Financial Crises Financial Crises and the Economy Part 1 2 Dynamics of Financial Crises 3

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