Savings Gluts and Financial Fragility

Money, liquidity and monetary policy

Patrick Bolton, Tano Santos and Jose A Scheinkman

The Review of Financial Studies, 2021, vol. 34, issue 3, 1408-1444

Abstract: We propose an incentive-based theory of how a savings glut produces financial fragility. Originators must be incentivized to produce high-quality assets. Assets are distributed to informed intermediaries or uninformed investors. A savings glut reduces origination incentives by compressing spreads between the prices paid for high-quality assets by informed intermediaries and prices paid by uninformed investors for generic assets. The narrowing of spreads relaxes intermediaries’ borrowing constraints, resulting in higher leverage. This generates financial fragility: intermediaries are more likely to become insolvent if unforeseen losses arise. Our model offers a coherent narrative of the run-up to the Global Financial Crisis.

JEL-codes: G01 G15 G23 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (7)

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