David M. Harrison, Ph.D.Real Estate FinanceTexas Tech University

Why Do FinancialIntermediares Exist? The Lemons Problem: Akerlof (QJE – 1970)

Suppose you want to buy a car. 10 cars are available for purchase in the marketplace. As an uninformed buyer, you are unable to distinguish between good cars and bad cars. Good cars have an open-market value of $4,500, while bad cars have an open-market value of $1,500. Based upon

your unique knowledge and entrepreneurial ability, you can generate $6,000 in revenue (not profit) if you are able to obtain a good car, but only $2,000 in revenue if you obtain a bad car. Furthermore, it is common knowledge that 50% of all cars in the marketplace are good cars (and hence, the remaining 50% are bad cars). Assuming you are a risk-neutral, profit-maximizing investor:

David M. Harrison, Ph.D.Real Estate FinanceTexas Tech University

Why Do FinancialIntermediares Exist? Delegated Monitoring: Diamond (JB – 1984)

Agency Cost Example:

David M. Harrison, Ph.D.Real Estate FinanceTexas Tech University

Why Do FinancialIntermediares Exist?

Other Explanations Liquidity Argument – Gorton & Pencchi (JF – 1990)

Credit Availability – Peterson & Rajan (JF/QJE-’94/’95)

Information Story – Berlin and Loeys (JF – 1988)

David M. Harrison, Ph.D.Real Estate FinanceTexas Tech University

Are Bank Loans Unique?

Eugene Fama – JME (1985)

Empirical Evidence

Conclusions:

David M. Harrison, Ph.D.Real Estate FinanceTexas Tech University

MBA Extension: Local Bank Rates

What is the average 30-year fixed mortgage interest rate in Lubbock?

What are the average fees associated with originating these loans?

What drives local mortgage rates?