Savings Gluts and Financial Fragility
54 Pages Posted: 8 Mar 2016 Last revised: 8 Jan 2018
Date Written: January 4, 2018
Originators produce higher quality assets at a private cost. These assets can either be bought by informed intermediaries or sold in a pool with low quality assets. Savings gluts diminish origination incentives because they compress the spread between the price paid for high quality assets and the price paid for the pool. The narrowing of the spreads relaxes borrowing constraints, which results in higher leverage. Thus savings gluts generate financial fragility - the sensitivity of financial intermediaries' equity to unforeseen contingencies. The model offers a coherent narrative of the run up to the crisis.
Keywords: savings glut, cream skimming, incentives for origination, leverage, financial fragility
JEL Classification: D8, G1
Suggested Citation: Suggested Citation