This is a Hand post, but it is actually just the normal authors of the blog. We all had the same idea at the same time 😀
Over at Anti-Dismal, Paul Walker reaches the conclusion that
The moral of the story, markets can deal with asymmetric information
In the case of bad and good banks. He states that banks are able to signal whether they are strong or not, and so government intervention is unnecessary.
However, this doesn’t seem to weigh up properly with the vast amount of literature that points out that bank runs are a concern resulting from asymmetric information (and multiple equilibrium – for economists this is because withdrawal decisions are strategic complements) and that a small amount of government intervention can help prevent said negative outcomes (here and here are seminal pieces).
Now there is a way that we can put both points of view together. Lets look at how the market is overcoming the asymmetric information problem:
At least one major US bank is advertising the fact that it refused TARP funds.
So the market was only able deal with asymmetric information in this case because the government created a mechanism that allowed banks to credibly signal (the TARP program). It is ONLY because the government created this mechanism that the individual banks could signal their “strength” credibly, thereby preventing an inefficient bank run equilibrium.
So I would change the moral of the story slightly to
markets can deal with asymmetric information, when the institutions are in place that allow them to credibly signal quality – an issue government can sometimes help with