Should We Have or Should We Have Not, and Who Should Have Paid?

We analyze an overlapping generations model which explicitly includes a secondary asset market. The economy is affected by a onetime shock which causes some of these assets to become toxic. As a response the government may intervene by buying these assets at market value and removing them from trade. When the shock is not anticipated we find that government intervention cannot improve upon the laissez-faire equilibrium. However, when agents anticipate that a crisis may occur, removing the toxic assets dominates laissez-faire, particularly when the toxic asset holders are financing the intervention scheme. Finally, we show that curbing incentives which drive investors to find high yield opportunities decreases the severity of a crisis once it occurs, but also output.