Collateral, Rationing, and Government Intervention in Credit Markets
William G. Gale
This paper analyzes the effects of government intervention in credit
markets when lenders use collateral, interest, and the probability of
granting a loan as potential screening devices. Equilibria with and without
rationing are examined. The principal theme is that credit policies operate
through their effect on the incentive compatibility constraint, which
inhibits high-risk borrowers from mimicking the behavior of low-risk
borrowers. Any policy that loosens (tightens) the constraint raises
Most government credit programs explicitly attempt to fund investors
that cannot obtain private financing. In the model presented here, these
subsidies increase the extent of rationing and reduce efficiency. In
contrast, policies that subsidize the nonrationed borrowers, or all
borrowers, are efficiency enhancing, and reduce the extent of rationing.
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