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Dædalus coming up in Dædalus: the meaning of Gerald Early, Henry Louis Gates, Jr., Glenda R. Carpio, David A. minority/majority Hollinger, Jeffrey B. Ferguson, Hua Hsu, Daniel Geary, Farah Grif½n, Dædalus Korina Jocson, Eric Sundquist, Waldo Martin, Werner Sollors, James Alan McPherson, Jeffrey B. Perry, Clarence Walker, Wilson Jeremiah Journal of the American Academy of Arts & Sciences Moses, Tommie Shelby, Amina Gautier, and others Fall 2010 race, inequality Lawrence D. Bobo, William Julius Wilson, Michael Klarman, Rogers Fall 2010: on the ½nancial crisis & economic policy Fall & culture Smith, Douglas Massey, Jennifer Hochschild, Martha Biondi, Cathy Cohen, James Heckman, Taeku Lee, Pap Ndiaye, Alford Young, on the Benjamin M. Friedman Introduction 5 Marcyliena Morgan, Richard Nisbett, Jennifer Richeson, Daniel ½nancial & Robert M. Solow Sabbagh, Roger Waldinger, and others crisis & Benjamin M. Friedman Is our ½nancial system serving us well? 9 economic policy Robert M. Solow The bigger they are . 22 the modern American David Kennedy, Lawrence Freedman, David Segal, Lawrence Korb, Luigi Zingales Learning to live with not-so-ef½cient military Robert L. Goldich, Danielle Allen, Andrew Bacevich, James Sheehan, markets 31 Brian Linn, Deborah Avant, Renée de Nevers, Errol Morris, Thomas Jeremy C. Stein Securitization, shadow banking Mahnken, Jonathan Shay, Charles J. Dunlap, Eugene Fidell, Martha & ½nancial fragility 41 McSally, William J. Perry, and others Lucian A. Bebchuk How to ½x bankers’ pay 52 Nolan McCarty, Political fortunes: on ½nance plus protecting the Internet as a public commons, public opinion &c. Keith T. Poole, & its regulation 61 Thomas Romer & Howard Rosenthal C.A.E. Goodhart Lessons from the ½nancial crisis for monetary policy 74 Robert E. Hall Fiscal stimulus 83 Edward L. Glaeser Housing policy in the wake of the crash 95 Barry Eichengreen International ½nancial regulation after the crisis 107 Peter Temin The Great Recession & the Great Depression 115 Alexander Hamilton From his writings 125 poetry Alice Notley The Codex Eats Me 127 U.S. $13; www.amacad.org Cherishing Knowledge · Shaping the Future Inside front cover: Traf½c passes by a ½nancial in- stitution’s headquarters in New York on Tuesday, April 14, 2009. Photograph © Andrew Harrer/ Bloomberg via Getty Images. A foreclosure sign is posted in front of a townhouse in Herndon, Virginia, November, 22, 2007. In the years following the housing market collapse of 2006 and 2007, banks and mortgage ½rms have ½led thou- sands of foreclosure notices against American homes. Photograph © Paul J. Richards/afp/Getty Images. Benjamin M. Friedman and Robert M. Solow, Guest Editors Phyllis S. Bendell, Managing Editor and Director of Publications D Micah J. Buis, Associate Editor Erica Dorpalen, Editorial Assistant Board of advisers Steven Marcus, Editor of the Academy Rosanna Warren, Poetry Adviser Committee on Publications Jerome Kagan, Chair, Jesse H. Choper, Denis Donoghue, Gerald Early, Linda Greenhouse, Jerrold Meinwald; ex of½cio: Leslie Berlowitz Dædalus is designed by Alvin Eisenman. The Academy dedicates this issue in memory of Carl Kaysen and Paul Samuelson, noted economists and active and esteemed members of the American Academy of Arts and Sciences. Dædalus Journal of the American Academy of Arts & Sciences The pavement labyrinth once in the nave of Reims Cathedral (1240), in a drawing, with ½gures of the architects, by Jacques Cellier (c. 1550–1620) Dædalus was founded in 1955 and established as a quarterly in 1958. The journal’s namesake was renowned in ancient Greece as an inventor, scien- tist, and unriddler of riddles. Its emblem, a maze seen from above, symbol- izes the aspiration of its founders to “lift each of us above his cell in the lab- yrinth of learning in order that he may see the entire structure as if from above, where each separate part loses its comfortable separateness.” The American Academy of Arts & Sciences, like its journal, brings togeth- er distinguished individuals from every ½eld of human endeavor. It was chartered in 1780 as a forum “to cultivate every art and science which may tend to advance the interest, honour, dignity, and happiness of a free, inde- pendent, and virtuous people.” Now in its third century, the Academy, with its nearly ½ve thousand elected members, continues to provide intellectual leadership to meet the critical challenges facing our world. Dædalus Fall 2010 Subscription rates: Electronic only for non- Issued as Volume 139, Number 4 member individuals–$43; institutions–$113. Canadians add 5% gst. Print and electronic © 2010 by the American Academy for nonmember individuals–$48; institu- of Arts & Sciences tions–$126. Canadians add 5% gst. Outside Securitization, shadow banking the United States and Canada add $23 for & ½nancial fragility postage and handling. Prices subject to change © 2010 by Jeremy C. Stein without notice. How to ½x bankers’ pay © 2010 by Lucian A. Bebchuk Institutional subscriptions are on a volume- The Codex Eats Me, from “Culture of One” year basis. All other subscriptions begin with (Penguin; forthcoming, March 2011) the next available issue. © 2010 by Alice Notley Single issues: current issue–$13; back issues Editorial of½ces: Dædalus, Norton’s Woods, for individuals–$16; back issues for institu- 136 Irving Street, Cambridge ma 02138. tions–$32. Outside the United States and Phone: 617 491 2600. Fax: 617 576 5088. Canada add $6 per issue for postage and han- Email: [email protected]. dling. Prices subject to change without notice. Library of Congress Catalog No. 12-30299 Claims for missing issues will be honored free of charge if made within three months of the isbn 978-0-262-75111-7 publication date of the issue. Claims may be Dædalus publishes by invitation only and as- submitted to [email protected]. Mem- sumes no responsibility for unsolicited manu- bers of the American Academy please direct all scripts. The views expressed are those of the questions and claims to [email protected]. author of each article, and not necessarily of Advertising and mailing-list inquiries may be the American Academy of Arts & Sciences. addressed to Marketing Department, mit Dædalus (issn 0011-5266; e-issn 1548-6192) Press Journals, 55 Hayward Street, Cambridge is published quarterly (winter, spring, summer, ma 02142. Phone: 617 253 2866. Fax: 617 253 fall) by The mit Press, Cambridge ma 02142, 1709. Email: [email protected]. for the American Academy of Arts & Sciences. Permission to photocopy articles for internal An electronic full-text version of Dædalus is or personal use is granted by the copyright available from The mit Press. Subscription owner for users registered with the Copyright and address changes should be addressed to Clearance Center (ccc) Transactional Report- mit Press Journals, 55 Hayward Street, ing Service, provided that the per-copy fee of Cambridge ma 02142. Phone: 617 253 2889; $12 per article is paid directly to the ccc, u.s./Canada 800 207 8354. Fax: 617 577 1545. 222 Rosewood Drive, Danvers ma 01923. The Printed in the United States of America by fee code for users of the Transactional Report- Cadmus Professional Communications, ing Service is 0011-5266/10. Address all other Science Press Division, 300 West Chestnut inquiries to the Subsidiary Rights Manager, Street, Ephrata pa 17522. mit Press Journals, 55 Hayward Street, Cam- bridge ma 02142. Phone: 617 253 2864. Newsstand distribution by Ingram Periodicals tn Fax: 617 253 1709. Email: journals-rights@ Inc., 18 Ingram Blvd., La Vergne 37086, and mit.edu. Source Interlink Distribution, 27500 Riverview fl Center Blvd., Bonita Springs 34134. The typeface is Cycles, designed by Sumner Postmaster: Send address changes to Dædalus, Stone at the Stone Type Foundry of Guinda 55 Hayward Street, Cambridge ma 02142. Peri- ca. Each size of Cycles has been sep arately odicals postage paid at Boston ma and at addi- designed in the tradition of metal types. tional mailing of½ces. Benjamin M. Friedman & Robert M. Solow Introduction The ½nancial meltdown of 2007 to 2009 folks. Apart from the sheer theater of it was surely a great spectacle. Mighty all, the main reason for caring about a names toppled like that statue of Saddam ½nancial crisis is the well-founded belief Hussein. Lehman Brothers, with a histo- that serious disturbance of the ½nancial ry spanning a century-and-a-half, just dis- system can impair the functioning of the appeared. Bear Stearns and even Merrill real economy, perhaps drastically. A well- Lynch–the same Merrill Lynch that had behaved ½nancial system makes the real taught generations of small investors to economy more ef½cient at producing be “bullish on America”–were sold off well-being for its inhabitants (though it at discounts suitable for used furniture. may parcel out income and wealth to spe- aig was rescued in the nick of time, but ci½c groups among those inhabitants in only with $182 billion of U.S. government ways that we and they may ½nd objection- assistance. Trillions of dollars of inves- able, and maybe even repugnant). But a tors’ wealth simply evaporated. One breakdown of the ½nancial system can could think, “Oh, well, easy come, easy inflict damage on the real economy, dam- go.” But still, trillions of dollars? It was a age that may last for years after the break- spectacle all right, but why did it really down has been repaired. And so it has. matter to the rest of us, who count our- These connections between the real selves merely as citizens of the republic? economy and the