Collateral Crises

Short-term, collateralized, debt is efficient if agents are willing to lend without producing costly information about the value of the collateral. When the economy relies on this informationally-insensitive debt, information is not renewed over time. If the value of collateral is mean reverting, there is a credit boom when firms with bad collateral start borrowing as the information about their collateral depreciates. The longer an economy remains in an information-insensitive regime, the smaller the fraction of collateral with information about their true value, and the larger the fraction of collateral that look similar. This creates fragility, since a small aggregate shock to collateral values is more likely to generate a large systemic collapse in output and consumption. Furthermore, if a crisis triggers information production, the economy takes longer to recover.