Alternatives to Government Regulations in the Financial

SectorJ.D. Han for Money (and Banking)

Eco 2154 PPP #4

We all know that Information Asymmetry is an intrinsic problem to the financial industry.

How can we help the Market Economy solve its own problems?

What are the market-endogenous, as opposed to exogenous government intervention, solutions to Information Asymmetry?

1) Information Market

Information Revolution may resolve Information Free Rider Problem

Then there occurs a Perfect Market of Information which will (almost) resolve Information Asymmetry

2) Mergers and Acquisitions will lead to More Information

Disclosures• M & A targets Firms with severe problems

of Principal and Agent (a Moral Hazard), and tries to correct them.

• M & A process reveals Moral Hazard problems of the target firm.

• M & A uses Leveraged Buy Out (LBO) with bonds, and replaces equities with bonds which carry more management monitoring through restrictive covenant.

3) New Forms of Financing rises for Close Management Monitoring: Private Equity• Private Equity is complex and elusive.

• What it does? One major function is Mezzanine Financing (preferred stocks, and subordinated bonds) combines Equities and Bonds with best of both worlds – Lenders can constantly and closely monitor management.

• related (confusingly) with Venture Capital (relatively new), Merchant Banking (as old as in 16th century)

• Japanese Banking, European Banking, and U.S. Financial Trusts(J.P. Morgan) before Glass-Steagall Act of 1933

• Gramm-Leach-Bliley Act of 1999 allows Financial Holding Company to become lenders(no meddling with management) as well as share-holders( who can do management monitoring), and boosts Private Equity(Merchant Banking)

• Performances in terms of Returns and Safety(Risk) are superior.

• The only problem is “social equity issue” or “protection of small investors” who go alongside with giants – U.S. has unique legal system to protect them: “Lender’s Liability and Equitable Surbordination”

• We should facilitate Information Revolution, and allows for active M & As and new forms of innovative financing formats.

• In reality, the government often tries to suppress them.

• Obama-Biden’s basic tone of objection to these pro-market evolutions may be wrong.