API 141

Finance

SYLLABUS
August 16, 2016

Akash Deep
 API 141 Finance
Syllabus
Akash Deep
August 16, 2016
HARVARD Kennedy School
API-141, Fall 2016
Finance

Faculty Akash Deep

Office Littauer-213
Telephone 617 495 1340
Email [email protected]
Office Hours Monday or Wednesday afternoons (sign-up outside Littauer-213)

Lectures Monday and Wednesday, 2:45pm to 4:00pm in Littauer-140

Review Session Friday, 11:45am to 1:00pm in Littauer-140

Faculty Assistant Jessica De Simone

Office Rubenstein 110A
Telephone 617 495 1415
Email [email protected]

Teaching Fellow Michael Biemann

Email [email protected]

COURSE DESCRIPTION
This introductory (but fast-paced) course provides a general survey of finance and investments. It
emphasizes an intuitive, logically rigorous understanding of the theory and practice of financial
markets, illustrating the concepts through examples and cases drawn from the public, private,
and non-profit sectors. Topics covered include: present value analysis and discounting,
diversification, the tradeoff between risk and return, market efficiency, pricing of stocks and
bonds, the capital asset pricing model, term structure of interest rates, the principle of arbitrage,
pricing of derivative securities (forwards, futures, and options), the use of derivatives for
hedging, risk management, and the regulation of financial markets.
AUDIENCE
The course is intended for students who are interested in learning the basic tools and techniques
of finance and how they are employed for the valuation of complex securities. While an intuitive
appreciation of the principles will be the primary objective, mathematical tools will be employed
to illustrate the implementation of these principles to practical cases. Any advanced mathematics
that is used will be developed in lectures and review sessions.
PREREQUISITE
It is assumed that students will be familiar with introductory concepts in economics (e.g. API
101) and basic (high school level) mathematics. Students with concerns about their backgrounds
are welcome to speak to the instructor. Basic computer spreadsheet skills will be expected, and
required to complete some of the assignments.

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REQUIREMENTS
The course must be taken for credit. No auditors please.
Attendance: An alert, inquisitive presence in each and every class is mandatory. Attendance in
review sessions is strongly advised but not required.
Readings: Students will be expected to have completed the assigned readings before class and
review them after class. Note that there are required readings for the first day of class.
Assignments: Weekly problem sets will be assigned throughout the course to illustrate and
reinforce the concepts presented in class as well as in preparation of the case discussions to
follow.
Exam: There will be in-class, closed book and closed notes midterm and final exams. No make-
up exams will be held.
Grading: Class Participation 10%
Written assignments 20%
Midterm Exam 30%
Final Exam 40%
MATERIALS
The textbook for the course, Essentials of Investments, 10th edition by Zvi Bodie, Alex Kane and
Alan Marcus, McGraw-Hill Irwin, 2017. The textbook can be purchased in hard copy or digitally
through McGraw-Hill Connect. Limited copies of the textbook are available on Reserve at the
HKS Library.
Readings and cases are available online on the Canvas site for this course. Non-Harvard students
should request a Harvard XID, following instructions on courses.harvard.edu.
Regular reading of financial news in publications such as The Wall Street Journal, The Financial
Times or the Business pages of The New York Times is strongly recommended.

OTHER RECOMMENDED (BUT NOT REQUIRED) FINANCE TEXTS

The following are some good introductory finance texts that overlap in parts with the material
covered in the recommended text for this class:
Corporate Finance, 10th edition, Stephen Ross, Jeffrey Jaffe, and Randolph Westerfield,
McGraw-Hill Financial, 2013.
Principles of Corporate Finance, 11th edition, Richard Brealey and Stewart Myers, McGraw-Hill
Financial, 2014.
Investment Science, 2nd edition, David Luenberger, Oxford University Press, 2013 (uses
calculus).
Financial Modeling, 4th edition, Simon Benninga, The MIT Press, 2014.

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TOPICS AT A GLANCE

No Date Topic Assignment

. due
1 Aug 31 (W) Introduction to finance and financial markets
Time
2 Sep 2 (F) Arbitrage and the Time value of money
3 Sep 7 (W) Valuing financial securities: Bonds
4 Sep 12 (M) Valuing financial securities: Equity A
Uncertainty
5 Sep 14 (W) Diversification, risk, and return measures
6 Sep 19 (M) Case: The State of South Carolina B
7 Sep 21 (W) Choosing a portfolio
8 Sep 26 (M) The Capital Asset Pricing Model C
Information
9 Sep 28 (W) Information
Efficient markets
10 Oct 3 (M) Case: Communications Satellite Corporation D
11 Oct 5 (W) Case: Long Term Capital Management

12 Oct 12 (W) Midterm Exam

Risk Management
13 Oct 14 (F) Introduction to risk management
14 Oct 17 (M) Forward and futures contracts
15 Oct 19 (W) Options
16 Oct 24 (M) Case: Dozier Industries E
17 Oct 26 (W) Pricing of options
Oct 31 (M) No class
18 Nov 2 (W) Guest speaker F
19 Nov 7 (M) Case: BASIX G
Real Options
20 Nov 9 (W) Real options
21 Nov 14 (M) Case: Bidding for Antamina H
Financial Institutions
22 Nov 16 (W) Case: Federal Deposit Insurance Corporation
23 Nov 21 (M) Case: Subprime Meltdown
24 Nov 28 (M) Financial institutions and policy

25 Nov 30 (W) Review

Dec 9 Final exam (3 to 6pm)

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INTRODUCTION TO FINANCE AND FINANCIAL MARKETS

Required Readings

Introduction to finance and financial markets

The New Capitalism: How unfettered finance is fast reshaping the global economy, Martin Wolf, The
Financial Times, June 19, 2007.

Introduction: Finance, Stewardship, and Our Goals, in Finance and the Good Society, Robert J. Shiller,
Princeton University Press, 2012, 1-15.

The slumps that shaped modern finance, The Economist, April 12, 2014.

Chapters 1 and 2, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017. (Optional reading:
Chapters 3 and 4)

Further Reading

Finance and the Good Society, Robert J. Shiller, Princeton University Press, 2012.

The Wall Street Journal Guide to Understanding Money & Investing, Kenneth M. Morris and Virginia B.
Morris, Simon and Schuster, 2004.

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TIME: TIME VALUE OF MONEY

The three pillars of finance are time, uncertainty and information. This section focuses on the first of
these pillars time to examine how the occurrence of cash flows at different points in time affects their
value. The resultant concept of present value (and future value) is then used to value general investment
opportunities and securities, and in particular bonds and stocks.

Required Readings

Arbitrage and the Time value of money

Arbitrage and Financial Decision Making, Chapter 3 in Corporate Finance, 3rd edition, Jonathan Berk
and Peter DeMarzo, Pearson Addison Wesley, 2014.

The Time Value of Money, Chapter 4 in Corporate Finance, 3rd edition, Jonathan Berk and Peter
DeMarzo, Pearson Addison Wesley, 2014.

Valuing financial securities: Bonds

Chapter 10, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Valuing financial securities: Equity

Chapter 13 and Section 14.1, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Further Reading

Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2nd edition, Aswath
Damodaran, John Wiley & Sons, 2006.

The Handbook of Fixed Income Securities, 8th edition, Frank J. Fabozzi, McGraw-Hill Professional, 2012.

Fixed Income Securities: Tools for Today's Markets, 2nd edition, Bruce Tuckman, John Wiley & Sons,
2002.

Security Analysis, 6th edition, Benjamin Graham and David Dodd, McGraw-Hill Education, 2008.

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UNCERTAINTY: PORTFOLIO SELECTION

The future embodies risk and this section explores the ramifications of uncertainty in the cash flows from
securities on investors who, by nature, are risk averse. The risk embedded in securities is measured by
viewing them as part of a diversified portfolio. The result is not only a theory about the relationship
between risk and return but also a surprisingly simple portfolio investment strategy. These concepts are
used to ask the question: should the state of South Carolina invest its public employees pension savings
in stocks?

Required Readings

Diversification, risk, and return measures

Chapter 5, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.
Risk, Market Sensitivity, and Diversification, William F. Sharpe, Financial Analysts Journal, January-
February, 1995, 84-88.

Choosing a portfolio

Chapter 6, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.
You, too, Can Short Stocks, Business Week, March 22, 1999.
Long & Short: Its a Tough Job, So Why Do They Do It? The Backward Business of Short Selling,
Jesse Eisinger, The Wall Street Journal, March 1, 2006.

Case: The State of South Carolina

HBS case # 9-201-061

South Carolina, State Treasurer's Office, 1998. Until last year the state pension fund, with over
$17 billion in assets, was barred by the state constitution from investing in equities. After the
constitution was amended, the state government has to decide how much to invest in equities,
and what assets to choose.
The Long, Sorry Tale of Pension Promises, Roger Lowenstein, The Wall Street Journal, October 1,
2013.
Study Questions:
1. What is the problem that South Carolina faced in 1999 with regard to the management of its
pension funds? How do you know that there is a problem?
2. What are the potential solutions?
3. What should the objectives of pension investing be?
4. How do stocks versus bonds rank on these dimensions?

Further Reading

Modern Portfolio Theory and Investment Analysis, 9th edition, Edwin Elton, Martin Gruber, Stephen
Brown and William Goetzmann, John Wiley & Sons, 2014.
Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment
Strategies, 5th edition, Jeremy J. Siegel, McGraw-Hill Education, 2014.

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UNCERTAINTY: THE CAPITAL ASSET PRICING MODEL

The Capital Asset Pricing Model is the most widely used model in finance. It provides a simple
relationship between risk and return that is useful in addressing a range of different problems in finance
such as portfolio selection, valuation of projects and securities, and performance appraisal. The
Communications Satellite Corporation case uses this model to ascertain the rate of return that this
regulated monopoly, which was set up to launch the first communication satellites, should be allowed to
earn.

Required Readings

The Capital Asset Pricing Model

Sections 7.1-7.3, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Risk and Return The Economist, February 2nd 1991, 72-73.

Does the Capital Asset Pricing Model Work?, David Mullins, Jr., Harvard Business Review, January-
February, 1982, 105-113.

Case: Communications Satellite Corporation

HBS Case No. 276-195

In January 1975, the Federal Communications Commission (FCC) concluded an 11-year
investigation of the appropriate regulation of Comsat. One of the most important of these was the
determination of the fair rate of return on Comsat's capital. Both the qualitative assessment of
risk and the use of analytical techniques had been suggested by eminent experts.

Study Questions:
1. How risky is the investment in Comsat compared to an investment in AT&T and other
companies? Which of these risks can be classified as systematic and which as unsystematic?
2. By what methods can the cost of equity and cost of capital be estimated for Comsat (or any other
company)?
3. How convincing is the argument of the trial staff? What are the implications of its reasoning and
recommendation for all parties concerned and for future government regulated companies such as
Comsat?
4. What relation, if any, should there be between a firms cost of capital and its investment
decisions?

Further Reading

Asset Pricing, revised edition, John H. Cochrane, Princeton University Press, 2005.

The Econometrics of Financial Markets, John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay,
Princeton University Press, 1996.

Dynamic Asset Pricing Theory, 3rd edition, Darrell Duffie, Princeton University Press, 2001.

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INFORMATION: EFFICIENT MARKETS

The third pillar of finance is information. The prices of financial securities also reveal information about
underlying factors that need not be only economic but also political and social. How quickly and
appropriately prices reflect information is referred to as a measure of efficiency of markets. No topic in
finance is more contentious, and none more important. Not surprisingly, the Nobel Prize in Economics for
2013 was awarded to two economists Eugene Fama and Robert Shiller who hold seemingly opposite
views on the subject.

Required Readings

Efficient markets

Chapter 8, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Trendspotting in asset markets, Nobel Prize Committee, 2013.

Random Walks in Stock Market Prices, Eugene F. Fama, Financial Analysts Journal, January-
February, 1995, 75-80.

Efficient Markets, Random Walks, and Bubbles, Chapter 11 in Irrational Exuberance, 3rd edition,
Robert Shiller, Princeton University Press, 2015.

The Efficient Market Hypothesis and its Critics, Burton G. Malkiel, Journal of Economic Perspectives,
Winter 2003 17 (1) 59-82.

Case: Long-Term Capital Management

All Bets Are Off: How the Salesmanship And Brainpower Failed At Long-Term Capital Michael Siconolfi,
Anita Raghavan, et. al., The Wall Street Journal, November 16, 1998, p A1.
Even with the market tremors of the preceding weeks, no one foresaw the earthquake about to rock
Greenwich, Conn., one summer morningLTCM's biggest bets were blowing up, and no one could do
anything about it. By 11 a.m., the fund had lost $150 million in a wager on the prices of two
telecommunications stocks involved in a takeover. Then, a single bet tied to the U.S. bond market lost $100
million. Another $100 million evaporated in a similar trade in Britain. By day's end, LTCM had hemorrhaged
half a billion dollars The carnage that weekend set off events unprecedented in the world of high finance,
culminating with a $3.625 billion bailout funded by a consortium of 14 Wall Street banks and engineered by
the Federal Reserve. LTCM lost more than 90% of its assets by the time it was bailed out, and the markets
were roiled for weeks. Longer term, it forced many of the world's most sophisticated institutional investors
to redefine the ways they manage risk

Study Questions:
1. Identify some the main investment strategies adopted by LTCM.
2. What was the role of arbitrage in these investment strategies?
3. What was the source of risk in these investment strategies?
4. What does the LTCM experience tell you about market efficiency?

"Death by the Numbers", David Kestenbaum, Science, February 26, 1999, 1244-1247.

Hedge Fund Existential Richard Bookstaber, Financial Analysts Journal, September/October

2003, pp 19-23.

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Further Reading

Manias, Panics & Crashes: A History of Financial Crises, 4th edition, Charles P. Kindleberger, John
Wiley & Sons, 2000.

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, 2nd edition, Nassim
Nicholas Taleb, Texere, 2004.

Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay, 1841.

Inefficient Markets: An Introduction to Behavioral Finance, Andrei Shleifer, Oxford University Press,
Clarendon Lectures in Economics, 2000.

Irrational Exuberance, 3rd edition, Robert Shiller, Princeton University Press, 2015.

A Random Walk Down Wall Street, revised edition, Burton G. Malkiel, W. W. Norton & Co., 2015.

Thinking, Fast and Slow, Daniel Kahneman, Farrar, Straus and Giroux, 2011.

When Genius Failed: The Rise and Fall of Long-Term Capital Management, Roger Lowenstein, Random
House Publishing Group, 2001.

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RISK MANAGEMENT: INTRODUCTION

If it is risk that begets return, then managing risk is what finance is all about. Risk Management seeks not
only to provide tools for how to reduce (or take on) risk but also provides guidance of when risk
management might add value. Derivatives help make the job of the risk manager, and the speculator,
easier!

Required Readings

Introduction to Risk Management

A Framework for Risk Management, Kenneth Froot, David Scharfstein, and Jeremy Stein, Harvard
Business Review, November-December 1994, 91 - 102.

The Fantastic System of Side Bets, in Against the Gods: The Remarkable Story of Risk, Peter Bernstein,
1996, 304-328.

Financial WMD?, The Economist, January 22, 2004.

Further Reading

Against the Gods: The Remarkable Story of Risk, Peter Bernstein, John Wiley & Sons, 1998.

The Essentials of Risk Management, Michel Crouhy; Dan Galai, Robert Mark, McGraw-Hill Professional,
2006.

Risk Management and Derivatives, Ren M. Stulz, Thomson South-Western, 2003.

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RISK MANAGEMENT: FORWARD AND FUTURES CONTRACTS

Forward contracts simply lock in the price for transactions in the future. This simple innovation that gets
rid of price uncertainty thus becomes the most obvious and powerful tool for hedging risk. But how much
should you pay for this innovation? The Dozier case examines this question in the context of currency
markets, the largest financial market by notional volume.

Required Readings

Forward and Futures Contracts

Sections 17.1-17.4, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Should We Fear Derivatives?, Ren Stulz, Journal of Economic Perspectives, Summer 2004 18 (3),
173-192.

Case: Dozier Industries

"Dozier Industries" in G. Feiger and B. Jacquillat, International Finance, Allyn and Bacon, 1982.
A US company has just secured its first international sales contract in the UK. But the CFO of
the company is concerned that if the value of the pound sterling depreciated, the viability of the
project could be impaired.

Study Questions:
1. What risk/s does Dozier face?
2. What other financial instruments or derivatives could Dozier have used to hedge its risk
exposure? What would the benefits and costs be?
3. What changes would you recommend for Dozier with regard to the manner in which it bids for
international contracts?

Further Reading

Options, Futures, and Other Derivatives, 9th edition, John C. Hull, Prentice Hall, 2015.

Futures, Options, and Swaps, Robert W. Kolb and James A. Overdahl, Wiley-Blackwell, 2007.

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RISK MANAGEMENT: OPTIONS

Financial option contracts constitute some of the most advanced derivative products traded in financial
markets today. At the same time they resemble insurance contracts that are some of the earliest financial
contracts recorded in history. The celebrated Black-Scholes option pricing is simply an application of the
principle of arbitrage pricing but it represents a breakthrough in financial engineering and risk
management that has remained unmatched by any other development in the theory of finance. Yet this so
called rocket science can be deployed to effectively address the age old and widely pervasive policy
challenge of insuring crops against the vagaries of weather as illustrated in the BASIX case.

Required Readings

Options

Chapter 15, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.

Of Butterflies and Condors, The Economist, February 16, 1991, 58-59.

Case: BASIX

HBS Case # 207-099

BASIX, an Indian microfinance corporation, must decide whether to continue to sell weather
insurance to its clients. A brand-new financial product, weather insurance pays if measured
rainfall during the growing season falls below a pre-specified limit. Mr. Sattaiah, managing
director of the BASIX's bank, considers a revised insurance policy for the coming season,
weighing the costs and potential risks of expanding the product against the potential benefits.

Study Questions:
1. What fundamental risks do BASIX customers face? How exposed are they to weather risk?
2. How well did BASIXs earlier efforts to offer rainfall insurance fare? Why?
3. As a BASIX Customer Service Agent, how would you explain and sell the proposed policy to
farmers?
4. A simulation based on the rainfall distributions shown in Exhibit 6 of the case suggests that a Rs.
125 policy would have an expected payout of Rs. 83. Is the proposed price appropriate?
5. Is this a product that BASIX should be selling to farmers? If not, how might you modify it to
make it better serve farmers needs?

Pricing of Options

Chapter 16, Essentials of Investments, 10th edition, Bodie, Kane & Marcus, 2017.
A Calculus of Risk, Gary Stix, Scientific American, May 1998, 92-97.
So many options, The Economist, November 7, 2002.

Further Reading

Options, Futures, and Other Derivatives, 9th edition, John C. Hull, Prentice Hall, 2015.

Derivatives: An Introduction, Robert A. Strong, South-Western, 2002.

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REAL OPTIONS

Real world opportunities are very similar to financial options because they represent choices that are not
necessarily obligations. Furthermore, these choices can be made based upon the availability of new
information. Viewing real opportunities as real options allows one not only to exercise these choices more
judiciously but also permits the valuation of information itself. In the Antamina case, the Peruvian
government devises a novel risk-sharing mechanism to privatize a mine that also seeks to skew the
investment incentives of the developer.

Required Readings

Real Options

The Options Approach to Investment, Avinash Dixit and Robert Pindyck, Harvard Business Review,
May-June 1995, 105 115.

Case: Bidding for Antamina

HBS Case # 297-054

In June 1996, executives of the multinational mining company RTZ-CRA are contemplating
bidding to acquire the Antamina copper and zinc mine in Peru. The Antamina project is being
offered for sale by auction as part of the privatization of Peru's state mining company. RTZ-CRA
has to determine what the mine is worth, and to recommend whether and how RTZ-CRA should
bid in the upcoming auction. The bidding rules put in place by the Peruvian government dictate
that each company's bid contain two components: an up-front cash amount and the amount the
bidder will invest to develop the property, if development is warranted after further exploration
is completed.

Study Questions:
1. If the winning bidder was legally forced to develop Antamina after completing the exploration
phase, and was required to pay the Peruvian government upfront for this project, how would you
determine the price that they would be willing to pay?
2. If the winning bidder could choose whether or not to develop Antamina after completing the
exploration phase, but was required to pay the Peruvian government upfront for the right to
develop the project, how would you determine the price that they would be willing to pay?
3. What are the incentives brought about by the different auction designs described above, and that
chosen by the Peruvian government? Do the rules seem to meet what you perceive to be the goals
of the government?

Further Reading

Real Options and Investment under Uncertainty: Classical Readings and Recent Contributions, edited by
Eduardo S. Schwartz and Lenos Trigeorgis, The MIT Press, 2004.
Investment under Uncertainty, Avinash Dixit and Robert Pindyck, Princeton University Press, 1994.
Real Options: Managerial Flexibility and Strategy in Resource Allocation, Lenos Trigeorgis, The MIT
Press, 1996.
Real Options in Capital Investment: Models, Strategies, and Applications, edited by Lenos Trigeorgis,
Greenwood Publishing Group, 1995.

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FINANCIAL INSTITUTIONS

In this final section, we use the tools developed in the course to analyze two of the most significant
financial policy challenges of the last century: the Great Depression of the 1930s and the Great Recession
of 2008. What did the policy makers do? Where did they succeed? Where did they fail? And what lessons
can we learn?

Required Readings

Case: The U.S. Banking Panic of 1933 and Federal Deposit Insurance Corporation

HBS Case # 799-097

On March 3 banking operations in the United States ceased ... the government has been
compelled to step in for the protection of depositors and the business of the nation. As President
Franklin D. Roosevelt spoke these words to Congress on March 9, 1933, the nation's troubled
banking system lay dormant. More than 9,000 banks had ceased operations between the stock
market crash in October 1929 and the banking holiday in March 1933. The economy was in the
midst of the worst economic depression in modern history. Out of the ruins, birth was given to
the FDIC three months later when the President signed the Banking Act of 1933.

Study Questions:
1. What do commercial banks do? Does this mix of activities make economic sense? How does this
expose commercial banks to risks?
2. Recall from the BASIX case that any insurance contract can also be viewed as an option. Can this
perspective be utilized to understand deposit insurance?
3. What regulatory measures can seek to mitigate the risks of banking?

Banking on the State, Andrew G Haldane and Piergiorgio Alessandri, based on a presentation delivered
at the Federal Reserve Bank of Chicago twelfth annual International Banking Conference on The
International Financial Crisis: Have the Rules of Finance Changed?, Chicago, 25 September 2009.

Case: Subprime Meltdown: American Housing and Global Financial Turmoil

HBS Case # 708-042

The Federal Reserve and the U.S. Treasury have lately widened the federal safety net more
quickly and more aggressively than at any time since the New Deal era. Indeed, a recent front-
page headline in this newspaper, Confidence Ebbs for Bank Sector and Stocks Fall, had
distinctly Depression overtones. (You could almost envision the next line: Hoover Urges
Calm.) And not since the Depression (under the Reconstruction Finance Corporation) has the
government bought significant equity in private firms, as the Treasury has sought the authority
to do in the case of Fannie Mae and Freddie Mac. At least during the 1930s, legislation followed
months of deliberation and public hearings. The proffered fixes to todays fast-moving crises are
worked out hastily and in private.
- Roger Lowenstein, The New York Times, July 27 2008

Study Questions:
1. Is residential housing a safe asset?
2. What is securitization? How was securitization used by policymakers in the United States to
channel housing finance to homebuyers?

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3. What were the major changes in the nature of housing finance markets from the 1990s until the
onset of the financial crisis?

Getting Up to Speed on the Financial Crisis: A One-Weekend-Readers Guide, Gary Gorton and
Andrew Metrick, Journal of Economic Literature, 2012, 50:1, 128150.

Financial Institutions & Policy

To prepare for this final case session, please review the last two cases:
The U.S. Banking Panic of 1933 and Federal Deposit Insurance
Subprime Meltdown: American Housing and Global Financial Turmoil
and read the concluding chapters (read more if you wish) from two reports on the financial crisis:
Conclusions of the Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report,
page xv to xxviii (14 pages) in the authorized edition, January 2011
Find the full report at http://fcic.law.stanford.edu/report
Conclusion, The Squam Lake Report: Fixing the Financial System, page 79-87 (9 pages), 2010
Find the full report at http://www.stat.unc.edu/faculty/cji/890-11/SquamLake.pdf

Study Questions
1. Should Roosevelt agree to deposit insurance? Are there alternatives to reforms of the banking
system that might be preferable from an economic point of view?
2. How has deposit insurance worked in the United States and around the world over the last
seventy years?
3. What regulatory measures have been used to mitigate the risks of banking?
4. In what ways did the structure and risks of Government Sponsored Enterprises Fannie Mae and
Freddie Mac resemble those of commercial banks? How were they different?
5. Overall would you say that the housing finance system has functioned well or poorly through the
last decade?
6. What changes would you recommend to the institutions that shape and regulate the housing
finance system?

Further Reading

The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the
Financial and Economic Crisis in the United States, Financial Crisis Inquiry Commission, 2011.

Balancing the Banks: Global Lessons from the Financial Crisis, Mathias Dewatripont, Jean-Charles
Rochet and Jean Tirole, translated by Keith Tribe, Princeton University Press, 2015.

The Squam Lake Report: Fixing the Financial System, Kenneth R. French, Martin N. Baily, John Y.
Campbell, John H. Cochrane, Douglas W. Diamond, Darrell Duffie, Anil K Kashyap, Frederic S.
Mishkin, Raghuram G. Rajan, David S. Scharfstein, Robert J. Shiller, Hyun Song Shin, Matthew J.
Slaughter, Jeremy C. Stein and Ren M. Stulz, Princeton University Press, 2010.

Too Big to Fail, Andrew Ross Sorkin, Viking Press, 2009.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead, Alan S. Blinder,
Penguin Press, 2013.

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