GARY B. GORTON, Yale School of Management, National Bureau of Economic Research (NBER)
Email: gary.gorton@yale.edu

How did problems with subprime mortgages result in a systemic crisis, a panic? The ongoing Panic of 2007 is due to a loss of information about the location and size of risks of loss due to default on a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. Subprime mortgages are a financial innovation designed to provide home ownership opportunities to riskier borrowers. Addressing their risk required a particular design feature, linked to house price appreciation. Subprime mortgages were then financed via securitization, which in turn has a unique design reflecting the subprime mortgage design. Subprime securitization tranches were often sold to CDOs, which were, in turn, often purchased by market value off-balance sheet vehicles. Additional subprime risk was created (though not on net) with derivatives. When the housing price bubble burst, this chain of securities, derivatives, and off-balance sheet vehicles could not be penetrated by most investors to determine the location and size of the risks. The introduction of the ABX indices, synthetics related to portfolios of subprime bonds, in 2006 created common knowledge about the effects of these risks by providing centralized prices and a mechanism for shorting. I describe the relevant securities, derivatives, and vehicles and provide some very simple, stylized, examples to show: (1) how asymmetric information between the sell-side and the buy-side was created via complexity; (2) how the chain of interlinked securities was sensitive to house prices; (3) how the risk was spread in an opaque way; and (4) how the ABX indices allowed information to be aggregated and revealed. I argue that these details are at the heart of the answer to the question of the origin of the Panic of 2007.

CORRADO MALBERTI, Bocconi University - Institute of Comparative Law (IDC)
Email: corrado.malberti@unibocconi.it

This study provides some descriptive statistics on tender offers launched in the Italian market between 1998 and 2007. In 1998 the Italian government approved the Consolidated Law of Finance that substantially reformed the law on takeovers, and courageously reorganized this subject-matter.

In 2007, however, the Italian legislature was required to implement the European directive on takeover bids. Thus, after ten years a new reform modified the sections of the Consolidated Law on tender offers. The harmonization of the Italian law to the European directive creates an evident break between the old and the new regulation, and this separation makes possible to assess how the original provisions on tender offers were put in practice and how successful the different part of this regulation have been.

In particular, I examine some data on the classes of securities involved in tender offers, on the different types of mandatory and voluntary bids provided by the Italian law, on delistings, squeeze-outs, sell-outs, and on tender offers made on securities issued by companies that are not subject to the mandatory bid rule.

GARY B. GORTON, Yale School of Management, National Bureau of Economic Research (NBER)
Email: gary.gorton@yale.edu

Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.

KURT DEW, Advisory Task Force, Multinational Corps - Iraq
Email: kurtdew@gmial.com

We produce evidence of an important non-market factor creating higher expected returns at greater risk for global banks. We find that the banks most exposed to this profitable source of risk tend to be less regulated than those less exposed; suggesting profits depend in part on operating outside the rules. On the other hand, we find the large regulated banks that qualify for the Internal Ratings - Based Approach to Capital Adequacy under Basel II - based Rules tend to have low exposures to our profitable source of banking risk. Yet the enormous losses taken by banks during the subprime mortgage crisis have largely been taken by these highly regulated banks rather than unregulated banks exposed to profitable risk. We will explain that regulations themselves encouraged banks to take these risks, and to report them in a manner confusing to stockholders. Examining the microeconomics of bank risk-taking, we contrast three modern approaches to risk management: regulation-protected use of off-balance-sheet methods, standard investment-banking off-balance-sheet devices, and the off-balance-sheet Macquarie Model. We evaluate the transparency to investors of risks using the three methods, finding regulation-based methods least transparent to investors; the Macquarie Model, most transparent. This analysis suggests two possibilities: that current rules-based bank regulation is a blight on the banking system and that profitable banks have become renegades, increasingly closed to public scrutiny. Both are arguably bad things. We propose a way forward.

LEONARDO GIANI, University of Siena - Department of Economic Law
Email: leonardo.giani@unisi.it
RICCARDO VANNINI, University of Siena
Email: riccardo.vannini@unisi.it

This work aims to show how the present banking regulations of two very different countries like U.S. and Italy can be viewed as two outcomes of the same evolutionary path. By summing up the legislative evolution of both countries and putting it into its historical economic context, the present work wants to show two things. First, both systems have been and are just two different answers to the same problems. Second, after the World War II the globalization started to prevail on the other forces, driving both countries to adopt more similar and converging legislations.

JOSEPH F. MORRISSEY, Stetson University - College of Law
Email: jmorriss@law.stetson.edu

Amidst all the recent publicity surrounding government action in combating corporate wrong-doing (passage of the Sarbanes-Oxley Act and the prosecution of the top brass at Enron and other scandal-ridden companies) little attention has been focused on the dramatic reform of the securities regulations that was enacted in late 2005. This article attempts to survey and assess the merits of that reform.

The new regulations essentially provide that most companies no longer have to comply with basic restrictions on the securities offering process that have been the cornerstone of the securities regulatory regime since its inception in 1933. Chief among these restrictions are those pertaining to communications. Where communications have traditionally been widely curtailed during a new offering of securities to the public, the new reforms now allow most companies to communicate with the public relatively freely. Further, the heightened liability that attached to communications prior to the reforms will not apply to the new free communications. In the name of efficiency the restrictions and heightened liability have been eliminated. At the same time, I will argue, investors actually are being left more vulnerable to potential manipulations of corporate wrongdoers. In addition, the article will directly call into question whether the SEC has in fact exceeded its rule making authority by altering so dramatically the very character of the regulatory regime that the Securities Act sought to construct.

FOTIOS PASIOURAS, University of Bath - School of Management, Central Bank of Indonesia, Coventry University - Faculty of Business, Environment & Society
Email: f.pasiouras@bath.ac.uk
SAILESH TANNA, Coventry University - Department of Economics, Finance and Accounting - Faculty of Business, Environment and Society
Email: bsx043@coventry.ac.uk
C. ZOPOUNIDIS, Technical University of Crete - Department of Production Engineering and Management
Email: kostas@dpem.tuc.gr

This paper uses stochastic frontier analysis to provide international evidence on the impact of the regulatory and supervision framework on bank efficiency. Our dataset consists of 2,853 observations from 615 publicly quoted commercial banks operating in 74 countries during the period 2000-2004. We investigate the impact of regulations related to restrictions on bank activities and the three pillars of Basel II on cost and profit efficiency of banks, while controlling for other country-specific characteristics. Our results suggest that regulations and incentives that enhance market discipline, and higher supervisory power of the authorities, increase both cost and profit efficiency. Stricter capital requirements have a positive impact on cost efficiency but negative impact on profit efficiency. We observe the opposite effect in the case of restrictions on bank activities, with higher restrictions having a negative influence on cost efficiency but positive influence on profit efficiency.

VICENTE JAKAS, Deutsche Bank AG, Finance BAC Corporate and Investment Bank
Email: vicente.jakas@db.com

This paper reviews the literature and discusses the concept of lender of last resort (LOLR) with reference to the problem of systemic risk. The origin and criticisms of the modern theory on systemic risk are briefly reviewed. Similarly, the policy implications arising from the concept of LOLR, the moral hazard, the costs of bearing emergency assistance and the associated systemic risk are all discussed. It is shown that the LOLR facility for individual institutions, as opposed to the whole financial system, seems to reduce moral hazard. According to the reviewed literature, the LOLR should apply to institutions under liquidity constraints but solvent, despite the difficulties involved in determining solvency in the short run. Similarly, Central Banks are expected to assume a coordinating and supervisory role, and act as crises manager with the authority to oblige banks to monitor their risks and penalise bank management where appropriate. Finally, the difficulties of implementing the concept of LOLR in the context of international crisis are briefly examined.