Global Imbalances and Financial Fragility.

The article discusses the U.S. financial crisis and develops a stylized model to demonstrate how global imbalances has driven the U.S. securitization boom and bust. The period up to the end of the year 2006 where the growth in asset demand pushes up asset prices and lowers risk and interest rates is examined. The foreign demand for debt instruments increases the equilibrium level of leverage of the U.S. financial sector. When the shock turns negative, as in the post-2006 period, the foreign demand turns toxic with high leverage leading to an economic downturn and rising risk. The behavior of leverage and the demand for U.S. assets are discussed.