Lessons from the Financial Crisis

ROBERT W. KOLB is the Frank W. Considine Chair of Applied Ethics and Professor of Finance at Loyola University, Chicago. Before this, he was the assistant dean, Business and Society, and director, Center for Business and Society, at the University of Colorado at Boulder and department chairman at the University of Miami. Kolb has authored over twenty books on finance, derivatives, and futures, as well as numerous articles in leading finance journals.

• Acknowledgments xvEditor’s Note xviiIntroduction xixPART I Overview of the Crisis 11 Leverage and Liberal Democracy 3George Bragues2 A Property Economics Explanation of the Global Financial Crisis 9Gunnar Heinsohn and Frank Decker3 Of Subprimes and Sundry Symptoms: The Political Economy of the Financial Crisis 17Ashok Bardhan4 The Political Economy of the Financial Crisis of 2008 23Roger D. Congleton5 The Global Financial Crisis of 2008: WhatWent Wrong? 31Hershey H. Friedman and Linda Weiser Friedman6 The Roots of the Crisis and How to Bring It to a Close 37James K. Galbraith7 Enron Rerun: The Credit Crisis in Three Easy Pieces 43Jonathan C. Lipson8 The Global Crisis and Its Origins 51Peter L. Swan9 Four Paradoxes of the 2008–2009 Economic and Financial Crisis 59John E. Marthinsen10 Understanding the Subprime Financial Crisis 69Steven L. SchwarczPART II Causes and Consequences of the Financial Crisis 7711 The Origins of the Financial Crisis 79Martin N. Baily, Robert E. Litan, and Matthew S. Johnson12 Ten Myths about SubprimeMortgages 87Yuliya Demyanyk13 The Financial Crisis: How Did We Get Here and Where Do We Go Next? New Evidence on How the Crisis Spread Among Financial Institutions 95James R. Barth, Tong Li, Lu Wenling, and Glenn H. Yago14 A Decade of Living Dangerously: The Causes and Consequences of theMortgage, Financial, and Economic Crises 103Jon A. Garfinkel and Jarjisu Sa-Aadu15 Making Sense of the Subprime Crisis 109Kristopher S. Gerardi, Andreas Lehnert, Shane M. Sherlund, and Paul Willen16 Miraculous Financial Engineering or Legacy Assets? 119Ivo Pezzuto17 TheMaking and Ending of the Financial Crisis of 2007–2009 125Austin Murphy18 The SubprimeMortgage Problem: Causes and Likely Cure 133Ronald D. Utt19 Sequence of Asset Bubbles and the Global Financial Crisis 139Abol Jalilvand and A. G. (Tassos) MalliarisPART III Borrowers 14720 The Past, Present, and Future of Subprime Mortgages 149Shane M. Sherlund21 FHA Loans and Policy Responses to Credit Availability 155Dr. Marsha Courchane, Rajeev Darolia, and Dr. Peter Zorn22 The Single-Family Mortgage Industry in the Internet Era: Technology Developments and Market Structure 163Forrest Pafenberg23 Speed Kills? Mortgage Credit Boom and the Crisis 175Giovanni Dell’Ariccia, Deniz Igan, and Luc Laeven24 SubprimeMortgages:What We Have Learned From a New Class of Homeowners 181Todd J. Zywicki and Satya Thallam25 Rating Agencies: Facilitators of Predatory Lending in the SubprimeMarket 191David J. ReissPART IV The Process of Securitization 19726 A Primer on the Role of Securitization in the Credit Market Crisis of 2007 199John D. Martin27 Incentives in the Originate-to-DistributeModel of Mortgage Production 209Robert W. Kolb28 Did Securitization Lead to Lax Screening? Evidence from Subprime Loans 217Benjamin J. Keys, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig29 Tumbling Tower of Babel: Subprime Securitization and the Credit Crisis 225Bruce I. Jacobs30 The Incentives of Mortgage Servicers and Designing Loan Modifications to Address the Mortgage Crisis 231Larry Cordell, Karen Dynan, Andreas Lehnert, Nellie Liang, and Eileen Mauskopf31 The Contribution of Structured Finance to the Financial Crisis: An Introductory Overview 239Adrian A.R.J.M. van Rixtel and Sarai Criado32 Problematic Practices of Credit Rating Agencies: The Neglected Risks ofMortgage-Backed Securities 247Phil Hosp33 Did Asset Complexity Trigger Ratings Bias? 259Vasiliki Skreta and Laura Veldkamp34 The Pitfalls of Originate-to-Distribute in Bank Lending 267Antje Berndt and Anurag GuptaPART V RiskManagement and Mismanagement 27535 Behavioral Basis of the Financial Crisis 277J. V. Rizzi36 Risk Management Failures During the Financial Crisis 283Dr. Michel Crouhy37 The Outsourcing of Financial Regulation to Risk Models 293Erik F. Gerding38 The Future of Risk Modeling 301Elizabeth Sheedy39 What Happened to Risk Management During the 2008–2009 Financial Crisis? 307Michael McAleer, Juan-Angel Jim´enez-Martin, and Teodosio P´erez-Amaral40 Risk Management Lessons from the Global Financial Crisis for Derivative Exchanges 317Jayanth VarmaPART VI The Problem of Regulation 32541 Regulation and Financial Stability in the Age of Turbulence 327David S. Bieri42 The Financial Crisis of 2007–2009: Missing Financial Regulation or Absentee Regulators? 337George G. Kaufman and A. G. Malliaris43 The Demise of the United Kingdom’s Northern Rock and Large U.S. Financial Institutions: Public Policy Lessons 345Robert A. Eisenbeis and George G. Kaufman44 Why Securities Regulation Failed to Prevent the CDO Meltdown 355Richard E. Mendales45 Curbing Optimism in Managerial Estimates Through Transparent Accounting: The Case of Securitizations 361Stephen Bryan, Steven Lilien, and Bharat Sarath46 Basel II Put on Trial: What Role in the Financial Crisis? 369Francesco Cannata and Mario Quagliariello47 Credit Rating Organizations, Their Role in the Current Calamity, and Future Prospects for Reform 377Thomas J. Fitzpatrick IV and Chris Sagers48 Global Regulation for GlobalMarkets? 383Michael W. Taylor and Douglas W. Arner49 Financial Regulation, Behavioral Finance, and the Global Financial Crisis: In Search of a New RegulatoryModel 391Emilios AvgouleasPART VII Institutional Failures 40150 Why Financial Conglomerates Are at the Center of the Financial Crisis 403Arthur E. Wilmarth51 Corporate Governance and the Financial Crisis: A Case Study from the S&P 500 411Brian R. Cheffins52 Secondary-Management Conflicts 419Steven L. Schwarcz53 The Financial Crisis and the Systemic Failure of Academic Economics 427David Colander, Michael Goldberg, Armin Haas, Alan Kirman, Katarina Juselius, Brigitte Sloth, and Thomas Lux54 FannieMae and FreddieMac: Privatizing Profit and Socializing Loss 437David Reiss55 Disclosure’s Failure in the SubprimeMortgage Crisis 443Steven L. SchwarczPART VIII The Federal Reserve, Monetary Policy, and the Financial Crisis 45156 Federal Reserve Policy and the Housing Bubble 453Lawrence H. White57 The Greenspan and Bernanke Federal Reserve Roles in the Financial Crisis 461John Ryan58 The Risk Management Approach to Monetary Policy: Lessons from the Financial Crisis of 2007–2009 467Marc D. Hayford and A. G. Malliaris59 Reawakening the Inflationary Monster: U.S. Monetary Policy and the Federal Reserve 475Kevin Dowd and Martin Hutchinson60 The Transformation of the Federal Reserve System Balance Sheet and Its Implications 483Peter StellaPART IX Implications of the Crisis for Our Economic Systems 49361 Systemic Risk and Markets 495Steven L. Schwarcz62 The Transmission of Liquidity Shocks During the Crisis: Ongoing Research into the Transmission of Liquidity Shock Suggests the Emergence of a Range of New Channels During the Credit Crisis 501Nathaniel Frank, Brenda Gonz´alez-Hermosillo, and Heiko Hesse63 Credit Contagion From Counterparty Risk 509Philippe Jorion and Gaiyan ZhangPART X International Dimensions of the Financial Crisis 51764 Only in America? When Housing Boom Turns to Bust 519Luci Ellis65 The Equity Risk Premium Amid a Global Financial Crisis 525John R. Graham and Campbell R. Harvey66 Australia’s Experience in the Global Financial Crisis 537Christine Brown and Kevin Davis67 Collapse of a Financial System: An Icelandic Saga 545Tryggvi Thor Herbertsson68 Iceland’s Banking Sector and the Political Economy of Crisis 551James A. H. S. Hine and Ian Ashman69 The Subprime Crisis: Implications for Emerging Markets 559William B. Gwinner and Anthony B. SandersPART XI Financial Solutions and Our Economic Future 56970 The Long-Term Cost of the Financial Crisis 571Murillo Campello, John R. Graham, and Campbell R. Harvey71 Coping with the Financial Crisis: Illiquidity and the Role of Government Intervention 579Bastian Breitenfellner and Niklas Wagner72 Fiscal Policy for the Crisis 587Antonio Spilimbergo, Steven Symansky, Olivier Blanchard, and Carlo Cottarelli73 The Future of Securitization 595Steven L. Schwarcz74 Modification ofMortgages in Bankruptcy 601dam J. Levitin75 The Shadow Bankruptcy System 609Jonathan C. Lipson76 Reregulating FannieMae and FreddieMac 617Dwight M. Jaffee77 Would Greater Regulation of Hedge Funds Reduce Systemic Risk? 625Michael R. King and Philipp Maier78 Regulating Credit Default Swaps 633Houman B. ShadabIndex 641