Huang, HaizhouXu, Chenggang2019-04-241999-07Huang, Haizhou, and Chenggang Xu. “Financial Institutions, Financial Contagion, and Financial Crises.” CID Working Paper Series 1999.21, Harvard University, Cambridge, MA, July 1999.http://nrs.harvard.edu/urn-3:HUL.InstRepos:39402526This paper endogenizes financial contagion and financial crises from financial institutions. We show that financial crises can emanate from financial institutions which generate soft-budget constraints (SBC). The prevailing SBC in an economy distort in-formation such that the interbank lending market faces a “lemon” problem. The lemon problem in the lending market may contribute to bank-run contagions and can lead to the collapse of the lending market while inducing a run on the economy. Moreover, due to the lemon problem in the financial system, a rational government policy in this economy will lead to a SBC trap that all the illiquid banks are to be bailed out. In comparison, we show that an economy with a predominance of diversified financial institutions will be featured by hard-budget constraints. From this point, we show mechanisms that in this economy firms disclose timely information to the banks and to the financial market as a whole. Thus bank runs can be stopped, contagious risks contained and financial crisis prevented.en-USResearch Paper or Report2019-04-24