Collateral Booms and Information Depletion
69 Pages Posted: 20 Apr 2019
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Collateral Booms and Information Depletion
Collateral Booms and Information Depletion
Date Written: April 16, 2019
Abstract
We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.
Keywords: credit booms, collateral, information production, crises, misallocation
JEL Classification: E32, E44, G01, D80
Suggested Citation: Suggested Citation