Tuesday, 25 August 2009

Asymmetric information: banking version (updated)

Peter Klein over at the Organization and Markets blog writes
At least one major US bank is advertising the fact that it refused TARP funds. Bernanke and Co. must be unhappy, as they insisted that all large banks take the money to avoid tainting those that actually needed it
In other words, markets are finding way to undo the government's attempt at preventing the truth about the financial conditions of banks from coming out.

If you are a strong bank, you can signal this to people by pointing out that you didn't need or take TARP funds. As Klein writes,
The irony in all this is that government intervention in financial markets is usually justified by claims about asymmetric information: consumers can’t distinguish reliable from unreliable banks, insurers can’t tell healthy from unhealthy people, and so on, leading to a rash of adverse-selection problems that market mechanisms cannot solve. Actually the reverse is true: low-quality but politically connected financial institutions rely on government intervention to enforce a pooling equilibrium, preventing the market signaling and screening that would otherwise take place.
The moral of the story, markets can deal with asymmetric information.

Update: At TVHE the Hand talks about Bank runs and TARP.

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