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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2024 Grand Challenge: Business Resilience
Market-Based Solutions to Vital Economic Issues
Aug 1, 2019

Liquidity And the Structure Of Intermediation


In the run up to the financial crisis, the essential functions financial intermediaries played seemed to become less important. Commercial and industrial loans, as well as residential mortgages, the quintessential banking products, were securitized and sold. At the same time, the “skin in the game” intermediaries held in their activities (such as securitizations) diminished, while their leverage increased. Some have suggested these developments stemmed from rising agency problems in the financial sector. Instead, we attribute them to rising liquidity in real asset markets. Under a variety of circumstances, prospective liquidity tends to enhance firm leverage, which crowds out both internal and external corporate governance as supports to debt. This tends to make debt returns more skewed. We develop a general theory of the interaction between intermediary activities, intermediary capital structure, and real asset market liquidity.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.  

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