CHRISTOPHER WHALEN, Institutional Risk Analytics
Email: cwhalen@institutionalriskanalytics.com

Despite the considerable media attention given to the collapse of the market for complex structured assets that contain subprime mortgages, there has been too little discussion of why this crisis occurred. The Subprime Crisis: Cause, Effect and Consequences argues that three basic issues are at the root of the problem, the first of which is an odious public policy partnership, spawned in Washington and comprising hundreds of companies, associations and government agencies, to enhance the availability of affordable housing via the use of creative financing techniques. Second, federal regulators have actively encouraged the rapid growth of over-the-counter (OTC) derivatives and securities by all types of financial institutions. And third, also bearing blame for the subprime crisis is the related embrace by the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board of fair value accounting. After reviewing the Bush administration's proposed solutions as flawed, this article recommends a strategy for subprime crisis resolution. Job one is to rebuild market confidence in structured assets by going back to first principles on issues such as market transparency, standardization of contracts, and accounting treatment. By reducing complexity on the trade of structured assets through simple deal structures and providing investors with the information they need to analyze collateral, for example by requiring SEC registration and public pricing of assets, much of the current liquidity problem is ameliorated.

DANNY BEN-SHAHAR, Technion - Israel Institute of Technology
Email: dannyb@technion.ac.il
EYAL SULGANIK, Interdisciplinary Center Herzliyah - Arison School of Business
Email: sulganik@idc.ac.il

We adopt the Shapley value approach to examine the fair allocation of the depreciation and amortization charges among the time periods of the asset's useful life. Essentially, the allocation under the Shapley value solution rewards each time period of the asset's useful life with a share of the earnings that corresponds to its responsibility in the earnings-generating process. The latter is thus consistent with the recent developments in accounting standards, which maintain that the depreciation and amortization methods should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. Interestingly, we show that the Shapley value solution always conforms to a set of fundamental accounting requirements such as the matching principle and the impairment test. Moreover, we show that, unless the asset is associated with constant revenues and/or extremely profitable investments, the Shapley value solution can never coincide with the prevalent straight-line depreciation method. Finally, we identify the family of earnings patterns for which the Shapley value solution coincides with the equal surplus and the economic depreciation methods. Depreciation and amortization in this study apply to all types of assets (tangible and intangible); however, they are particularly significant for costly investments such as real estate, machinery, and customer relations.

ADAM LEVITIN, Georgetown University - Law Center
Email: levitin@post.harvard.edu
JOSHUA GOODMAN, Columbia University, Graduate School of Arts and Sciences, Department of Economics
Email: jg2394@columbia.edu

This paper examines the policy assumption underlying the special protection given to home mortgages in bankruptcy - namely that protecting lenders from losses in bankruptcy will encourage them to lend more and at lower rates, thus encouraging homeownership. This paper tests this policy assumption empirically using both current and historical mortgage market data. Current mortgage origination pricing, private mortgage insurance premiums, and secondary market pricing all indicate that mortgage markets are indifferent to bankruptcy modification risk. Historical mortgage pricing data from the 1980s and 1990s, when a particularly significant type of modification was permitted in almost half of federal judicial districts, also indicates that mortgage markets are largely indifferent to bankruptcy modification risk.

MICHAEL S. BARR, University of Michigan Law School
Email: msbarr@umich.edu
SENDHIL MULLAINATHAN, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)
Email: mullain@fas.harvard.edu
ELDAR SHAFIR, Princeton University
Email: shafir@princeton.edu

Choosing a mortgage is one of the biggest financial decisions an American consumer will make. Yet it can be a complicated one, especially in today‘s environment where mortgages vary in dimensions and unique features. This complexity has raised regulatory issues. Should some features be regulated? Should product disclosure be regulated? And most basic of all, is there a rationale for regulation or will the market solve the problem? Current regulation of home mortgages is largely stuck in two competing models of regulation - disclosure and usury or product restrictions - neither of which take adequate account of behavioral psychology or market incentives. This paper seeks to use insights from both psychology and economics to provide a framework for understanding both these models as well as to suggest fundamentally new models. We understand outcomes as an equilibrium interaction between individuals with specific psychologies and firms that respond to those psychologies within specific markets. Regulation must then account for failures in this equilibrium.