Secondary markets for long-term assets might be illiquid due to adverse selection. In this paper, I show that: (1) when agents expect a liquidity dry-up on such markets, they optimally choose to self-insure through the hoarding of nonproductive but liquid assets; (2) this hoarding behavior worsens adverse selection and dries up market liquidity; (3) such liquidity dry-ups are Pareto inefficient equilibria; (4) the government can rule them out. Additionally, I show that idiosyncratic liquidity shocks à la Diamond and Dybvig have stabilizing effects, which is at odds with the banking literature. ∗ This is the first chapter of my PhD Dissertation at ECARES, Universite libre de Bruxelles. I thank

We analyze government interventions to recapitalize a banking sector that restricts lending to …rms because of debt overhang. We …nd that the e ¢ cient recapitalization program injects capital against preferred stock plus warrants and conditions implementation on su ¢ cient bank participation. Preferred stock plus warrants reduces opportunistic participation by banks that do not require recapitalization, while conditional implementation limits free riding by banks that bene…t from lower credit risk because of other banks ’ participation. E ¢ cient recapitalization is pro…table if the bene…ts of lower aggregate credit risk exceed the cost of implicit transfers to bank debt holders.

We analyze incentive-efficient government bailouts within a canonical model of intra-firm moral hazard. Bailouts exacerbate the moral hazard of firms and managers in two ways. First, they make them less averse to failing. Second, the taxes to fund bailouts dampen their incentives. Nevertheless, if third-party externalities from keeping the firm alive are strong, bailouts can improve welfare. Our model suggests that governments should use bailouts sparingly, where social externalities are large and subsidies small; (often) eliminate incumbent owners and managers to improve a priori incentives; and finance bailouts through redistributive taxes on productive firms instead of forcing recipients to repay in the future.