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10 A unique feature of monoline capital requirements is that the firms are not allowed to distribute “earned premiums” as dividends for an extended period, often ten years. The idea is to match the holding period for the capital with the long-term recurrence rates of the catastrophe risks.

11 Government bailouts of entire firms are particularly costly because they indemnify all the firm’s creditors—a version of the debt overhang issue from corporate finance. This inefficiency is reflected in all of the government’s subprime mortgage bailouts. I thank Ken Froot for emphasizing for me this application of the debt overhang issue.

12 See Jaffee (2009).

Chapter 20 Froot: Toward Financial Stability

1 I modify markets with dealer-centric to indicate the many dealer-intermediated markets that exist, and to contrast them from exchange-centric markets.

2 The London Interbank Offered Rate (LIBOR) is a daily reference rate based on the interest rates at which banks borrow funds from other banks in the London wholesale money market (or interbank market). Overnight index swaps (OIS) are instruments that allow financial institutions to swap the interest rates they are paying without having to refinance or change the terms of the loans they have taken from other financial institutions.

3 A credit default swap (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults. CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the specified events occur. Sources: Wikipedia.

4 The average duration of the corporate bonds and CDS is about seven and five years, respectively.

Chapter 21 Arrow: Economic Theory and the Financial Crisis

1 I wish to thank the William and Flora Hewlett Foundation for research support.

2 Expected prices were taken to be functions of current prices, so that the functional relation between current demands and supplies and current prices becomes somewhat complicated.

3 This inconsistency between perfect foresight and informational limitations had already been argued by Morgenstern (1935). In a way, his involvement with the creation of game theory meant that a perfect foresight equilibrium could be shown, by the use of fixed-point theorems, to be a consistent concept, and so represents a step away from his earlier work. I now think his original position had important merits.

4 For a general survey, see Laffont and Martimort (2002).

5 Arguments of this type had already been raised in connection with the savings and loan crisis of the 1980s (see Kane [1989], though he was also concerned with government guarantees and regulation).

Chapter 22 Heal: Environmental Politics

1 This chapter is an extract from Whole Earth Economics, forthcoming.

2 He also won the Nobel Peace Prize in 1906, but for his role in mediating in the Russo-Japanese War rather than for his environmental work.

3 Quoted from the section titled “Lyndon B. Johnson and the Environment” at the EPA’s website (www.epa.org).

4 Quoted in J. Brooks Flippen, Nixon and the Environment (Alberquerque: University of New Mexico Press, 2000), p. 102.

Chapter 23 Gollier: Act Now, Later, or Never?

1. The so-called Ramsey Rule states that the socially efficient discount rate equals the real growth rate of consumption multiplied by the elasticity of the marginal utility of consumption. This Rule, including its underlying wealth effect, is the cornerstone of the current debate about the discount rate.

Chapter 24 Doherty: Climate Change

1 Howard Kunreuther, Jacqueline Meszaros, Robin Hogarth, and Mark Spranca, “Ambiguity and Underwriter Decision Processes,” Journal of Economic Behavior and Organization 26 (1995): 337-352. See also Neil Doherty and Paul Kleindorfer, “Ambiguity and the Insurance of Catastrophe Losses,” Working Paper, Risk and Decision Processes Center, Wharton School.

2 I should note, in all fairness, that