Lecture 5

Question 1

What is the main criticism of finance as discussed in the lecture?

Answer 1

Finance is often criticized for prioritizing the interests of bondholders and shareholders over other stakeholders and the social good.

Question 2

How can finance also benefit social good and other stakeholders?

Answer 2

Finance can align corporate incentives with social interests, demonstrating that investments and social well-being can improve simultaneously.

Question 3

What is the role of questions and debate in understanding finance?

Answer 3

Asking questions and engaging in debate are crucial for understanding the complexities and ethics of finance, helping to foster a deeper grasp of financial impacts on society.

Question 4

What is Tulip Mania and why is it significant in economic history?

Answer 4

Tulip Mania, occurring in the 1630s in Holland, is considered one of the first economic bubbles where tulip bulbs reached prices higher than homes, demonstrating how greed and fear can drive markets.

Question 5

What lesson does Tulip Mania provide about market prices?

Answer 5

Tulip Mania showed that the price of a good need not be connected to its functional utility, emphasizing the role of speculative trading in driving up prices.

Question 6

What were the contributing factors to the 1929 stock crash?

Answer 6

The 1929 stock crash was exacerbated by widespread margin trading and the inability of large individual investors to quell the market panic.

Question 7

What were the long-term effects of the 1929 stock crash?

Answer 7

The crash led to significant financial reforms aimed at increasing market stability and reducing the likelihood of similar future crises.

Question 8

What made the 1987 stock crash notable?

Answer 8

The 1987 stock crash was notable for the impact of computerized trading, which accelerated the market’s decline due to automated sell orders and loss limit orders.

Question 9

What were the responses to the 1987 stock crash?

Answer 9

Post-1987, limits were imposed on computer trading and electronic circuit breakers were introduced to provide time for human traders to assess and react to market situations.

Question 10

What triggered the Dot-com Bubble in 2000?

Answer 10

The Dot-com Bubble was triggered by speculative interest in any company with a Dot-com name, driven by the promise of a new era of hyper-profitable e-commerce, which led to inflated stock prices.

Question 11

What were some notable corporate casualties of the Dot-com Bubble?

Answer 11

Notable corporate casualties included Webvan and Pets.com, which failed due to unsustainable business models and inability to meet investor expectations despite high speculative investments.

Question 12

What was the investment outcome for those who bought into the Nasdaq at the peak of the Dot-com Bubble?

Answer 12

Investors who bought into the Nasdaq at its peak in March 2000 would have had to hold their stocks until May 1, 2015, just to break even, reflecting the severity of the bubble burst.

Question 13

What was the root cause of the 2008 MBS Crisis?

Answer 13

The crisis was rooted in the proliferation of Mortgage-Backed Securities (MBS) and the excessive risk-taking in housing loans, compounded by lax lending standards and aggressive investment banking practices.

Question 14

How did MBS contribute to the financial crisis?

Answer 14

MBS allowed for the pooling of mortgage loans into various risk tranches, misleading investors about the actual risk levels, which led to massive defaults and financial market instability when housing prices fell.

Question 15

What role did rating agencies play in the MBS crisis?

Answer 15

Rating agencies provided inflated ratings for MBS tranches, contributing to a false sense of security among investors, which exacerbated the crisis when the true risk levels became apparent.

Question 16

What cyclic pattern is observed in financial markets?

Answer 16

Financial markets often exhibit a cyclic pattern of bubbles and busts, which some believe is an inevitable component of the capitalist system.

Question 17

How do Keynesian economists view financial crisis avoidance?

Answer 17

Keynesian economists believe that financial crises can be avoided through appropriate policy adjustments, aiming to stabilize the market and prevent excessive speculative bubbles.

Question 18

What is the perspective of Hayekian economists on crisis avoidance?

Answer 18

Hayekian economists argue that avoiding financial pains in the short term through policy interventions only leads to greater problems later, advocating for minimal interference to allow markets to self-regulate.

Question 19

What is the Securities Act of 1933?

Answer 19

Enacted after the 1929 market crash, the Securities Act of 1933 focuses on disclosure, requiring that any material information about securities being offered for public sale must be fully disclosed.

Question 20

What is the purpose of the Glass-Steagall Act of 1933?

Answer 20

The Glass-Steagall Act was intended to prevent bank failures by separating commercial banking from investment banking and establishing the FDIC to insure bank deposits.

Question 21

What did the Securities and Exchange Act of 1934 establish?

Answer 21

The 1934 Act established the Securities and Exchange Commission (SEC) to regulate the secondary securities market, ensuring higher standards of honesty and fairness.

Question 22

What triggered the creation of the Sarbanes-Oxley Act?

Answer 22

Triggered by major accounting scandals such as Enron and WorldCom, Sarbanes-Oxley aims to improve corporate governance and enhance the accuracy of corporate disclosures.

Question 23

What are key provisions of the Sarbanes-Oxley Act?

Answer 23

Sarbanes-Oxley Act includes measures to protect whistleblowers, enhance auditor independence, and enforce the return of executives’ bonuses following misconduct.

Question 24

What was the purpose of the Dodd-Frank Wall Street Reform Act?

Answer 24

Dodd-Frank was enacted to address the issues revealed by the 2008 financial crisis, aiming to increase government oversight of the financial industry and limit excessive risk-taking.

Question 25

What is the Volker Rule, part of the Dodd-Frank Act?

Answer 25

The Volker Rule limits risky trading activities by banks, specifically prohibiting banks from engaging in proprietary trading and from owning or investing in hedge funds and private equity funds.

Question 26

How has the Dodd-Frank Act been modified in recent years?

Answer 26

Under the Trump administration in 2018, some provisions of Dodd-Frank were rolled back, aiming to lessen regulatory burdens and boost economic growth.

Question 27

What is the Magnitsky Act and its purpose?

Answer 27

The Magnitsky Act allows for the seizure of assets from foreign nationals who have committed human rights violations. It was championed in response to human rights abuses and corruption uncovered by lawyer Sergei Magnitsky.

Question 28

What are Non-Viability Contingent Capital (NVCC) and Conditional Convertible Bonds (CoCos)?

Answer 28

NVCC and CoCos are financial instruments designed to strengthen bank capital by converting bonds into equity under distressed conditions, shifting the risk of bank failure from taxpayers to bond investors.

Question 29

What is the principle of Pareto efficiency in free markets?

Answer 29

Pareto efficiency is a state where no individual can be made better off without making someone else worse off, implying an optimal allocation of resources where no waste exists.

Question 30

How does the free market philosophy relate to Adam Smith’s invisible hand?

Answer 30

The free market philosophy aligns with Adam Smith’s concept of the invisible hand, where market prices are driven by supply and demand dynamics, guiding resources to their most efficient uses without intentional regulation.

Question 31

What is the libertarian view on free markets and redistribution?

Answer 31

Libertarians generally support minimally regulated markets, arguing they lead to optimal outcomes over time.

However, they acknowledge that this does not address inequalities, which they believe should self-correct without intervention.

Question 32

How do current economic discussions relate to redistribution?

Answer 32

Current discussions emphasize the complexity of redistribution, exemplified by movements like Occupy Wall Street and policies on carbon trading and micro-finance, which aim to address economic and environmental injustices through market-based solutions.

Question 33

What does the slide suggest about the ethics of finance?

Answer 33

The ethics of finance is complex and outside the typical expertise of most finance professionals, leading them to focus more on law and regulations rather than building a philosophical approach to ethics.

Question 34

What correlation is noted between lawfulness and happiness in countries?

Answer 34

There is an observed correlation between lawfulness and happiness, with more lawful countries like Denmark, Finland, and Norway also being among the happiest, suggesting that effective laws contribute positively to societal well-being.

Question 35

What is the role of laws according to the discussion on finance and happiness?

Answer 35

Laws play a crucial role in shaping economies and societies by potentially improving the happiness of the participants, highlighting the importance of legal frameworks in economic systems.

Question 36

What reflection does the lecture aim to leave the students with regarding finance?

Answer 36

The lecture aims to leave students with an understanding that while finance is largely about numbers and regulations, its broader implications on ethics and law are complex and can impact societal happiness and well-being.