Study guide for Arnold Kling’s paper “Not What They Had in ...



Study guide for Arnold Kling’s paper “Not What They Had in Mind: A History of Policies that Produced the Financial Crisis of 2008.”

1. Kling argues that there were four components of the financial crisis: bad bets, leverage, domino effects, and runs. Briefly describe these four components. What evidence is there that bad bets alone would not cause the crisis?

2. Describe a “repo” loan.

3. Why should we be skeptical of the claim that the financial crisis was due to a loss of confidence by bank creditors?

4. According to Kling, what was the most important causal factor in the crisis?

5. Explain why regulatory policy cannot solve a problem once and for all? What is meant by the term regulatory arbitrage?

6. Why did disintermediation take place in the 1970s?

7. How did tax deductions for mortgage interest contribute to bad bets by consumers in housing?

8. How did the Basel Accords regarding risk-weighted capital requirements contribute to mortgage securitization? How did the Federal Reserve feel about the phenomenon of regulatory arbitrage occurring?

9. Why did the use of private credit agencies ratings of bank loan risk lead to “grade inflation” (that is, giving a loan a double A or triple A rating instead of an A or B rating)?

10. What is subordinated debt and how would it be useful in observing bank risk?

11. What is the time inconsistency problem faced by bank regulators? Read about The FDIC Improvement Act on p. 42 in your book. Which one of the four points is related to time inconsistency?

12. Economists generally think that barriers to entry which give firms monopoly power are inefficient. How might entry barriers and cheap deposit insurance enhance safety and soundness among financial institutions?

13. Describe some of the innovations in financial services that provide meaningful benefits to consumers and on net, were probably a good thing.

14. Describe how the innovations of credit scoring, private-label securities, and credit default swaps contributed to the boom in mortgage lending. What evidence does Kling offer that suggests that credit scoring models were not a beneficial innovation?

15. What is a credit default swap and which company was the major originator of credit default swaps? What does the buyer obtain when they purchase a CDS?

16. Describe the evidence for and against the use of monetary policy in promoting macroeconomic stability. (Macro stability means keeping the economy at full employment and providing price level stability).

17. Why do financial institutions have to signal investors\creditors? What were some traditional signals? How can excessive trust by investors\creditors lead to financial instability?

18. What policy reforms might contribute to an “easy to fix” financial system?

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