Moral Hazard and the Targeting of Crisis Intervention in Intermediation Chains

This thesis studies government intervention in intermediation chains when parties can take private action to avoid distress. The government seeks to prevent firm defaults from propagating through the credit chain and threatening financial stability. Firm level intervention attacks this problem at its source by rescuing distressed firms, but it also insures firms and reduces their incentive to avoid distress. The resulting incentive distortion weakens the intervention’s stabilizing effect and raises fiscal costs. Once the intermediary itself is subject to a moral hazard problem, the comparison becomes more complex. Intermediary intervention preserves firm effort but can reduce liquidity provision, whereas firm intervention can either raise or lower liquidity incentives. The optimal target therefore depends on which prevention margin is most distorted