Journal article: Financial liberalization increases growth, but leads to more crises and costly bailouts. We present a two-sector model in which liberalization, by allowing debt-denomination mismatch, relaxes borrowing limits in the financially constrained sector, but endogenously generates crisis risk. When regulation restricts external financing to standard debt, liberalization preserves financial discipline and may increase allocative efficiency, growth, and consumption possibilities. By contrast, under unfettered liberalization that also allows uncollateralized option-like liabilities, discipline breaks down, and efficiency falls. The model yields a testable gains-from-liberalization condition, which holds in emerging markets. It also helps rationalize the contrasting experience of emerging markets and the recent US housing crisis.