Restoring Financial Stability

VIRAL V. ACHARYA is Professor of Finance at New York University Stern School of Business and London Business School. He is Academic Advisor to the Federal Reserve Banks of New York and Philadelphia and Academic Director of the Coller Institute of Private Equity. Professor Acharya earned a Bachelor of Technology in computer science and engineering from the Indian Institute of Technology, Mumbai, and a PhD in finance from NYU Stern. He lives in New York City with his wife and son. MATTHEW RICHARDSON is the Charles E. Simon Professor of Financial Economics and the Sidney Homer Director of the Salomon Center for the Study of Financial Institutions at New York University Stern School of Business. Professor Richardson received his PhD in finance from Stanford University and his MA and BA in economics concurrently from the University of California at Los Angeles. He lives in New York City with his wife and three children.

Foreword xi

Acknowledgments xiii

Prologue: A Bird’s-Eye View
The Financial Crisis of 2007–2009: Causes and Remedies 1
Viral V. Acharya, Thomas Philippon, Matthew Richardson, and Nouriel Roubini

Part One Causes of the Financial Crisis of 2007–2009 57
Matthew Richardson

Chapter 1 Mortgage Origination and Securitization in the Financial Crisis 61
Dwight Jaffee, Anthony W. Lynch, Matthew Richardson, and Stijn Van Nieuwerburgh

Chapter 2 How Banks Played the Leverage Game 83
Viral V. Acharya and Philipp Schnabl

Chapter 3 The Rating Agencies: Is Regulation the Answer? 101
Matthew Richardson and Lawrence J. White

Part Two Financial Institutions 117
Matthew Richardson

Chapter 4 What to Do about the Government-Sponsored Enterprises? 121
Dwight Jaffee, Matthew Richardson, Stijn Van Nieuwerburgh, Lawrence J. White, and Robert E. Wright

Chapter 5 Enhanced Regulation of Large, Complex Financial Institutions 139
Anthony Saunders, Roy C. Smith, and Ingo Walter

Chapter 6 Hedge Funds in the Aftermath of the Financial Crisis 157
Stephen J. Brown, Marcin Kacperczyk, Alexander Ljungqvist, Anthony W. Lynch, Lasse H. Pedersen, and Matthew Richardson

Part Three Governance, Incentives, and Fair Value Accounting Overview 179
Viral V. Acharya and Rangarajan K. Sundaram

Chapter 7 Corporate Governance in the Modern Financial Sector 185
Viral V. Acharya, Jennifer N. Carpenter, Xavier Gabaix, Kose John, Matthew Richardson, Marti G. Subrahmanyam, Rangarajan K. Sundaram, and Eitan Zemel

Chapter 8 Rethinking Compensation in Financial Firms 197
Gian Luca Clementi, Thomas F. Cooley, Matthew Richardson, and Ingo Walter

Chapter 9 Fair Value Accounting: Policy Issues Raised by the Credit Crunch 215
Stephen G. Ryan

Part Four Derivatives, Short Selling, and Transparency 229
Viral V. Acharya

Chapter 10 Derivatives: The Ultimate Financial Innovation 233
Viral V. Acharya, Menachem Brenner, Robert F. Engle, Anthony W. Lynch, and Matthew Richardson

Chapter 11 Centralized Clearing for Credit Derivatives 251
Viral V. Acharya, Robert F. Engle, Stephen Figlewski, Anthony W. Lynch, and Marti G. Subrahmanyam

Chapter 12 Short Selling 269
Menachem Brenner and Marti G. Subrahmanyam

Part Five The Role of the Federal Reserve 277
Thomas F. Cooley and Thomas Philippon

Chapter 13 Regulating Systemic Risk 283
Viral V. Acharya, Lasse H. Pedersen, Thomas Philippon, and Matthew Richardson

Chapter 14 Private Lessons for Public Banking: The Case for Conditionality in LOLR Facilities 305
Viral V. Acharya and David K. Backus

Part Six The Bailout 323
Thomas F. Cooley and Thomas Philippon

Chapter 15 The Financial Sector Bailout: Sowing the Seeds of the Next Crisis? 327
Viral V. Acharya and Rangarajan K. Sundaram

Chapter 16 Mortgages and Households 341
Andrew Caplin and Thomas F. Cooley

Chapter 17 Where Should the Bailout Stop? 353
Edward I. Altman and Thomas Philippon

Part Seven International Coordination 363

Chapter 18 International Alignment of Financial Sector Regulation 365
Viral V. Acharya, Paul Wachtel, and Ingo Walter

About the Authors 377

Index 381