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.

KATHARINA PISTOR, Columbia University School of Law
Email: kpisto@law.columbia.edu

The financial market crisis that began to unfold in the summer of 2007 and has deepened in September 2008 has revealed some fundamental problems of global financial system: A massive market failure; a high level of global financial interdependence; regulatory failures at level of nation states; and a looming governance vacuum at the global level. The crisis has forced market participants, policy makers and regulators to enter unchartered waters in their attempt to stabilize financial markets and to begin the process of building a more sustainable governance regime for global financial markets. This paper suggests that elements of such a regime have already emerged over the course of the past eighteen months as major financial intermediaries, including banks and Sovereign Wealth Funds from different parts of the world began to engage in "organizational hedging" strategies (Stark). By partnering with institutions from different governance regimes, different expertise and institutional practices, they have created the foundation for transposing elements from one regime to another and recombining them to ultimately form a new governance regime. Whether or not this was their intention at the outset, the pattern of investments among these various organizations has taken the form of relational ties, which collectively can be described as an emergent global financial network. This paper argues that Global Network Finance (GNF) has the potential of performing critical governance functions for the global financial market place.

GABRIEL FAGAN, European Central Bank (ECB)
Email: Gabriel.Fagan@ecb.int
VITOR GASPAR, European Central Bank (ECB)
Email: vitor.gaspar@ecb.int

The move to monetary union in Europe led to convergence of interest rates among the participating countries. This was associated with notable cross-country differences in the behaviour of key macroeconomic aggregates. Compared to the low interest rate countries, former high interest rate countries experienced a boom in domestic demand, a deterioration of the current account and appreciation of the real exchange rate. This paper documents the key stylised facts of this experience and provides a compact two-country model, based on the Blanchard-Yaari setup, to analyze this phenomenon. This model, though simple, is able to broadly capture the main qualitative features of the adjustment. Using this model, we show that the creation of the monetary union leads to an increase in welfare for all generations in both country groups.

CLAUDIO MORANA, University of Piemonte Orientale, International Centre for Economic Research (ICER)
Email: Claudio.Morana@eco.unipmn.it

A new approach to mean-variance efficient portfolio selection is introduced. The method is based on realized regression theory and the regression based portfolio selection approach of Britten-Jones (1999), yielding a conditional version of the Britten-Jones (1999) method. Application to euro area stock markets diversification, differently from other standard approaches, actually yields a balanced and stable allocation of wealth, free from the problem of corner solutions, suggesting that diversification among euro area stock markets is still be feasible and desirable. Evidence that the monetary union may have had a much less important impact on the integration of euro area equity markets, as well as that the latter is still in progress, is provided.

JOHN DRIFFILL, University of London - Birkbeck College, Centre for Economic Policy Research (CEPR)
Email: j.driffill@bbk.ac.uk
ZENO ROTONDI, Universiy of Ferrara - Faculty of Economics
Email: zeno.rotondi@unicreditgroup.eu

The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.