EC223 Lecture Notes - Lecture 9: Freddie Mac, Bear Stearns, United States Treasury Security
Document Summary
A well-functioning financial system solves asymmetric information problems (moral hazard and adverse selection) so that the capital is allocated to its most productive uses. These asymmetric problems act as a barrier to efficient allocation of capital and are often described by economists as financial friction. When financial friction increases, financial markets are less capable of channelling funds efficiently from savers to households and firms with productive investment opportunity. A financial crisis occurs when information flows in financial markets experience a particularly large disruption, with the result that financial frictions increase charply and financial markets stop functioning. Dynamics of a financial crisis in advanced economies. Financial crisis can begin in several ways: mismanagement of financial liberalization/innovation, asset-price booms and busts, general increase in uncertainty caused by failures of major financial institutions. The seeds of a financial crisis are often planted when an economy introduces new types of loans or other financial products, known as financial innovation.
