Self-Fulfilling Credit Market Freezes

43 Pages Posted: 4 Jun 2010

See all articles by Lucian A. Bebchuk

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER)

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Multiple version iconThere are 3 versions of this paper

Date Written: May 2010

Abstract

This paper develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, with their success depending on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of alternative measures for getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, infusion of capital into banks, direct lending to operating firms by the government, and the provision of government capital or guarantees to finance or encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the financial crisis of 2008-2009.

Suggested Citation

Bebchuk, Lucian A. and Goldstein, Itay, Self-Fulfilling Credit Market Freezes (May 2010). NBER Working Paper No. w16031. Available at SSRN: https://ssrn.com/abstract=1617033

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

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