Rethinking the Financial Crisis
Publication Year: 2012
Published by: Russell Sage Foundation
Title Page, Copyright
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Samuel Johnson once observed that “when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.” So does the experience of a near-total financial collapse, especially when it triggers a long and deep recession and only hastily improvised and drastic actions by the Federal Reserve and the U.S. Treasury are able to ward off an even worse catastrophe. Naturally, then, more has been said and written about the financial crisis of 2008 to 2009 than anyone can hear or read. But the research and reflections described in this book ...
Part I. Rethinking Macroeconomics and Finance
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1. Some Reflections on the Crisis and the Policy Response
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I would like to thank the conference organizers for the opportunity to offer a few remarks on the causes of the 2007 to 2009 financial crisis, as well as on the Federal Reserve’s policy response. The topic is a large one, and today I will be able only to lay out some basic themes. In doing so, I will draw from talks and testimonies that I gave during the crisis and its aftermath, particularly my testimony to the Financial Crisis Inquiry Commission in September 2010 (Bernanke 2010). Given the time available, I will focus narrowly on the financial crisis and the...
2. This Time, It Is Not Different: The Persistent Concerns of Financial Macroeconomics
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When the Financial Times’s Martin Wolf asked former U.S. Treasury secretary Lawrence Summers what in economics had proved useful in understanding the 2007 to 2009 financial crisis and recession, Summers answered: “There is a lot about the recent financial crisis in Bagehot.” “Bagehot” here is Walter Bagehot’s 1873 book, Lombard Street. How is it that a book written 150 years ...
3. Credit Supply Shocks and Economic Activity in a Financial Accelerator Model
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This chapter uses the canonical “New Keynesian” macroeconomic model—augmented with the standard financial accelerator mechanism—to study the extent to which disruptions in financial markets can account for U.S. economic fluctuations during the 1985 to 2009 period. The key feature of the model is that financial shocks drive a wedge between the required return on capital ...
Part II. Rethinking Market Efficiency
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4. The Efficient-Market Hypothesis and the Financial Crisis
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The worldwide financial crisis of 2008 to 2009 left in its wake severely damaged economies in the United States and Europe. The crisis also shook the foundations of modern-day financial theory, which rests on the proposition that our financial markets are basically efficient. Critics have even suggested that the efficient-market hypothesis (EMH) was in large part responsible for the crisis....
5. Behavioral Finance in the Financial Crisis: Market Efficiency, Minsky, and Keynes
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We explore lessons from behavioral finance about the origins of the financial crisis of 2007 to 2009 and the likelihood of averting the next one. We argue that the crisis highlights the need to incorporate behavioral finance into our economic and financial theories. Psychology, including aspirations, cognition, emotions, and culture, is at the center of behavioral finance. We discuss this ...
6. Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis
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We present twelve facts about the mortgage crisis and argue that these facts refute the popular story that the crisis resulted from finance industry insiders deceiving uninformed mortgage borrowers and investors. Instead, we argue, borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices. We then show that ...
Part III. Rethinking Financial Innovation
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7. Ratings, Mortgage Securitizations, and the Apparent Creation of Value
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This chapter studies the criteria used by rating agencies when they rate structured products. The criterion used by Standard & Poor’s (S&P) and Fitch aims to ensure that the probability of a loss on a structured product with a certain rating is similar to the probability of a loss on a corporate bond with the same rating. The criterion used by Moody’s aims to ensure that the expected loss on ...
8. The Role of ABSs, CDSs, and CDOs in the Credit Crisis and the Economy
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The credit derivatives—ABSs, CDSs, and CDOs—played a significant role in the financial crisis of 2007 to 2008, affecting both the financial and real economy. This chapter explains their economic roles, using the credit crisis as an illustration. It is argued that ABSs are beneficial in that they provide previously unavailable investment opportunities to market participants, ...
9. Finance Versus Wal-Mart: Why Are Financial Services So Expensive?
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Despite its fast computers and credit derivatives, the current financial system does not seem better at transferring funds from savers to borrowers than the I would rather see Finance less proud and Industry more content.The role of the finance industry is to produce, trade, and settle financial con-tracts that can be used to pool funds, share risks, transfer resources, produce information, and provide incentives. Financial intermediaries are compensated for providing these services. Total compensation of financial intermediaries ...
10. Shadow Finance
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Shadow finance refers to all financial transactions that take place outside regulated and transparent financial markets. We emphasize one important reason why a shadow financial sector exists: to prevent the dissemination of valuable information about asset values and to “cream-skim” the most valuable assets away from public, transparent exchanges. We highlight one important ...
Part IV. Rethinking Financial Regulation
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11. The Political Economy of Financial Regulation after the Crisis
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The 2007 to 2008 financial crisis has spawned a vast and growing literature. This chapter tackles an aspect of the crisis—the political economy of financial regulation before and since the crisis—that up to now has not been extensively discussed...
12. Pay, Politics, and the Financial Crisis
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The Wall Street bonus culture—coupled with suspicions that the culture facilitated excessive risk-taking—led to an effective prohibition on cash bonuses for participants in the government’s Troubled Asset Relief Program (TARP) and to more sweeping regulation of executive compensation as part of the July 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. ...
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Page Count: 374
Publication Year: 2012