Why are downturns following episodes of high valuations of firms so severe and long? Why do firms take on high debt when they anticipate high valuations, and underperform subsequently? In this paper, we propose a theory of financing cycles where the control rights to enforce claims in an asset...

Short-term borrowing has often been blamed for precipitating financial crises. We argue that while the empirical association between a financial institution's, or country's, short-term borrowing and susceptibility to crises may, in fact, exist, the direction of causality is often precisely the...

Both investors and borrowers are concerned about liquidity. Investors desire liquidity because they are uncertain about when they will want to eliminate their holding of a financial asset. Borrowers are concerned about liquidity because they are uncertain about their ability to continue to...

Banks can create liquidity because their deposits are fragile and prone to runs. Increased uncertainty can make deposits excessively fragile in which case there is a role for outside bank capital. Greater bank capital reduces liquidity creation by the bank but enables the bank to survive more...

The cheapest way for banks to finance long term illiquid projects is typically to borrow short term from households. But when household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging runs....

Is there any need to "clean" up a banking system in the midst of a crisis, by closing or recapitalizing weak banks and taking bad assets off bank balance sheets, or can one wait till the crisis is over? We argue that an "overhang" of impaired banks that may be forced to sell assets soon can...

What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, it is certainly time to offer informed conjectures, and these are the...

We show in this paper that bank failures can be contagious. Unlike earlier work where contagion stems from depositor panics or ex ante contractual links between banks, we argue bank failures can shrink the common pool of liquidity, creating or exacerbating aggregate liquidity shortages. This...

We explore the connection between money, banks, and aggregate credit. We start with a simple real' model without money, where banks make loans repayable in goods and depositors hold claims on the bank payable on demand in goods. Aggregate production may be delayed in the economy. If so, we show...

Banks can fail either because they are insolvent or because an aggregate shortage of liquidity can render them insolvent. We show that bank failures can themselves cause liquidity shortages. The failure of some banks can then lead to a cascade of failures and a possible total meltdown of the...