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Business notes on Mishkin’s theory of information asymmetry
These notes provide a comprehensive comparison of two economic crisis based on
the Mishkin’s theory of information asymmetry. These notes examine the
underlying events that fuelled the occurrence of these global economic crises. The
notes also describe the Mishkin’s theory of information asymmetry and provides a
comparison and contrast between the two events in relation to the events that
happened during their time.
From these notes, students will learn about the concept of information asymmetry,
which is a situation where there is an unequal distribution of information between
different parties in a market. They will learn about the implications of this
inequality, such as the potential for market manipulation, and the potential for one
party to have an advantage over another. They will also learn about the role of
government regulations, such as disclosure requirements, in mitigating the effects
of information asymmetry. Finally, they will learn about Mishkin’s specific
theories on how information asymmetry can be managed to promote efficient
markets.
Comparing two economic crisis based on Mishkin’s theory of information asymmetry Introduction The world has experienced two great economic crisis, the Wall Street crash of 1929 and the great recession of2008/2009. These two events largely affected global economic events and activities. For every economic crisis, there are underlying factors that contribute to a collapse in the economy. This paper examines the underlying events that fuelled the occurrence of these global economic crises. The paper uses Mishkin’s theory of information asymmetry to compare and contrast the two events in relation to the events that happened during their time. The Wall Street crash of 1929 In 1929, Wall Street experienced the worst stock market collapse of the 20th century. The Black Days destroyed fortunes in the billions and plugged the world into a global economic crisis that took almost 25 years for the markets to recover from the shock. The Friday, October 25, October 25, 1929, has burned itself into historical memory as a symbol of the sudden end of an illusion. In the fall of 1929, a huge speculative bubble burst on Wall Street. The most momentous stock market crash of the 20th century marked the beginning of the global economic crisis (Blumenthal, 2013). Millions of investors lost their wealth. By 1932, nearly 90 percent of US stock wealth had gone up in smoke. In the end, 30 million Americans were out of work, industrial production, and several banks collapsed. It took almost a quarter of a century to recover from the consequences for the US economy. In 1954, the Dow Jones index reached 381 points, its high of 1929 (Borowiecki et al., 2022). But the fall of 1929 stock market crash was not the result of a single day (Blumenthal, 2013). The New York Stock Exchange (NYSE) was in a state of emergency for almost a week. In the end, nothing was the same as before - the
proclaimed Forbes magazine in 1929. "Our industry advances not in small leaps, but heroic steps." Basic economic rules seemed to have been suspended. The then US President Hoover jubilated: "Today we are closer to final victory over poverty than at any time in our history." And the then director of the car company General Motors, JJ Raskob, even claimed: "Since income can actually be increased in the stock market, I firmly believe that not only can anyone get rich, but that everyone has an obligation to do so." "A casino with loaded dice" Wall Street was where everyone wanted to cash in on the boom. Millions of private investors rushed to the stock exchange. "In 1929, you felt like you were in a casino with loaded dice. A few pikes attacking the many carp," a trader of those days later recalled. "I've seen shoeshine boys buy $50, worth of stock with only $500 in cash." The potential problem was that many investors financed their stock market adventures with loans. They speculated on credit. And the success proved them right - the price gains exceeded the lending rates many times over. Investors often only had to pay 10 or 20 percent down to the stockbroker, and the bank provided the rest. More than a tenth of the US market cap ended up being leveraged. And as long as prices continued to rise, there was nothing to worry about. Until everything collapsed. The crisis did not come out of the blue. The great crash of October 1929 did not hit American investors like a sudden natural disaster (Salsman, 2003). Long before that, it had become apparent - first tentatively, then more and more clearly - that the speculative bubble would not continue to grow forever. On December 8 December 8, 1928, the Dow Jones index gave way for the first time. A minus of 5 percent was on the books at the close of trading (Blumenthal, 2013). Nobody was alarmed by this. The price drop seemed like the exception that only confirmed the ongoing uptrend. Central bank blocks lending Only the US Federal Reserve was alarmed.
In early February 1929, the Federal Reserve Board asked American banks to stop using their reserves for speculative loans. The stock market prices fell again briefly. But investors were undeterred. Because they could no longer access long-term loans, they financed their stock market transactions with short-term loans. Their interest rate exploded from 12 to 20 percent - but the system worked: share prices continued to rise. On September 3 September 3, 1929, the Dow Jones peaked at 381 points. "Nice weather can't last forever" Meanwhile, the warning voices increased. Economist Roger Babson prophesied: "Nice weather can't last forever. The economic cycles are still valid today, Sooner or later the crash will come, and it can be terrible." Investors did not want to hear such warnings. The party was over, and trading started quietly on Black Thursday, October 24, 1929. Trading began with unexpected calm. After the hustle and bustle of the previous few days, the police had closed entire streets around Wall Street as a precaution. Black Thursday began as a beautiful fall day, sunny, maybe too cool (Klein, 2001). However, around eleven o'clock, a panic sell-off swept over the traders - for no apparent reason. There were riots on the trading floor, and trade collapsed several times. By 1 p.m., the rapid fall in prices had wiped out around eleven billion dollars (James, 2010). Leading banks tried to calm the mood. There were some bailouts on the stock market, and we have held a meeting of the heads of several financial institutions to discuss the situation. But because words no longer helped, the financial institutions finally intervened with support purchases (Gertler et al., 2018). Nearly 13 million shares changed hands that day - more than four times normal trading volume. In the evening, trading closed with a minus of just 2.1 percent. The worst seemed averted once again (Klein, 2003). But the next day, on October 25, the legendary Black Friday, things continued as before. Around eight million shares changed hands, and many papers
Notwithstanding, they energize resource cost expansion. Therefore, very low-interest rates combined with the availability of cheap credit and hype in certain markets lead to bubbles. There have been bubbles throughout the past two decades, including in internet stocks during the Neuer Markt, in real estate before the Great Recession, and most recently in cryptocurrencies and cannabis stocks. These bubbles all had one thing in common - a story and a vision of how big these industries will be in the future. It doesn't take much more than cheap money and a good story for a trend to develop (Gertler & Gilchrist, 2018). Interestingly, the momentum of the corresponding values is seen as confirmation of the trend. The “Fear of Missing Out," FOMO for short, then leads to more and more buyers entering the market. Small investors, in particular, are driving these bubbles with great support from the financial media. Between 2001 and 2006, a bubble developed in the US housing market. This was caused by low-interest rates and an increase in subprime loans. This means that loans were increasingly granted to people who did not have the appropriate credit rating. As the bubble continued to develop, lending became increasingly risky. Banks began issuing mortgage-backed securities. This enabled financial institutions to invest in the so-called subprime market, and the flow of capital was secured, at least temporarily (Christiano et al., 2015). Without these securities, the bubble would have burst much earlier. In addition, banks increased their leverage for proprietary trading. In addition, synthetic products related to the real estate lending market have been created to meet market demand. The Great Recession marked a global collapse of the world economy in the new millennium (Mian & Sufi, 2010). In this period the economy grew six percentage points less in real terms than if it had done so at the average rate of the previous twenty-eight years: during 1980-2007, the world's economy grew at an annual average of 3%, while from 2008 and until
2012, it did so at 1.8%, according to figures from the International Monetary Fund (Gertler & Gilchrist, 2018). 2008 was the beginning of the great economic crisis of this century, which originated in the United States but had a global reach. In Spain, job insecurity, lower wages, and increased unemployment led to policies of austerity and cuts whose consequences are still palpable today. The real estate bubble burst, the unemployment rate grew, and mortgages increased (Bates, 2012). The global economic system entered a recession and bank bailouts multiplied. As a result of this, on October 10, the greatest recorded fall of the Ibex 35 occurred. After two days, the European Union reports a bundle of measures to permit state intercession in bank capital and accelerate advances between banks (Burgard & Kalousova, 2015). As an outcome, the Ibex changes the following day; this time, a verifiable raise is caused. Yet, it didn't stop the emergency that was to come. The circumstance of Lehman Brothers didn't take more time to influence its ancestors in the rundown of the main monetary elements in the United States. The third, Merrill Lynch, was offered to Bank of America at an absurd cost, while the initial two, Goldman Sachs and Morgan Stanley, needed to become business banks to adapt to the surge of the emergency (Gertler & Gilchrist, 2018). The domino pieces were pushing against one another in seemingly a ceaseless and boundless breakdown that raised doubt about the unwavering quality of the worldwide financial framework. Applying Mishkin’s theory of information asymmetry Asymmetric information is an economic term and describes the situation in which two contracting parties do not have the same information when concluding and/or fulfilling a contract or market participants. As a result, problems such as adverse selection and moral hazards arise. Dealing with problems that result from asymmetric information is the subject of information
such credit rationing in small businesses can be saved. However, we verify how the guarantee system is not developed in the economy to reach desirable volumes. Information disparity was also a factor during the Wall Street crash. When stock market prices fell after Babson's speech, the "Babson crash" talk quickly began. The prophet was identified as the cause. The prophet was right; Babson was right. By October 19 October 19, 1929, the Dow Jones had lost over 15 percent of its value. Banks and investment companies tried to stabilize it with support purchases. Now the small investors woke up and got scared. In the days leading up to the big crash, the inflow of funds into the stock markets fell rapidly, and prices fluctuated more and more, albeit at high levels. "This stagnation also made private investors nervous. They had bought securities on credit and feared that they would no longer be able to service their debts if prices went down," recalled one trader. While the index continued to fall, trading volume increased dramatically—an alarming sign. At times, the stock market clerks could no longer keep up with the registration of the prices. It was hectic on the floor, and many brokers worked late. On October 23 October 23, the Dow Jones was already 80 points below its high. The media then launched into the task of economic disclosure. To do this, a common measure was adopted to bring technical knowledge closer to readers' daily experiences. This is explained by a 2014 study by the University of the Basque Country that points to the need for "lexical reworking and selection that makes the use of a vocabulary that allows broader cognitive anchors feasible," that is, a kind of translation that approximates the economic notions into the popular language (Elsby et al., 2010). Obviously, not all the terms —many of them neologisms and anglicisms— were adapted; they were also explained and repeated in the press until they became common terms.
But the media were not spared from the dire consequences of the economic crisis, so all this outreach work was carried out, in many cases, in precarious employment conditions. 78% of the journalists surveyed in a 2013 investigation on this subject affirm that the labor changes introduced between 2008 and 2012 affected the quality of information and labor well-being in a decisive way (Elsby, Hobijn & Sahin, 2010). According to Mishkin’s theory, asymmetric distribution of information in cooperation can affect both before and after the conclusion of a cooperation agreement. The problem of choosing the right partner arises. The asymmetric information prevents advantageous contractual relationships (Mavlanova et al., 2012). There is a bad contract or even no contract at all. Ex post, i.e., in cooperation itself, asymmetric information distribution can have a negative effect on the stability of the cooperation. Therefore one must try to get the problem of asymmetric information under control. Conclusion These two events are identified as the most crucial financial crisis in modern history. Based on the comparison conducted here, we can affirm that information asymmetry was a critical factor that fuelled these events. Financial markets have their own nature due to the fulfillment of their economic role, being in charge of allowing the growth of the economy through the financing of private initiatives, while at the same time guaranteeing the return of these funds to savers, obtaining, in turn, a commercial margin for its intervention and not only is this differential sufficient, but it must provide a margin for possible contingencies. To carry out these tasks, financial establishments are required to know the beneficiary of said operations and the particularities of the project/investment that is intended to be undertaken. Therefore, the quality and quantity of information that the different financial agents must handle must be as
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