The Financial Crisis: Causes and Lessons

Kenneth E. Scott

Journal of Applied Corporate Finance, 2010, vol. 22, issue 3, 22-29

Abstract: The author argues that the root cause of the recent crisis was a housing bubble whose origins can be traced to loose monetary policy and a government housing policy that continually pushed for lower lending standards to increase home ownership. The negative consequences of such policies were amplified when transmitted throughout the financial system by financial institutions through the process of securitization. In attempting to assess culpability for the crisis and identify possible reforms, the author focuses on three categories: 1 Defects in Financial Products: Without criticizing derivatives and the process of securitization, the author identifies the sheer complexity of the securities as a major source of the problem—for which the solution is a simpler security design combined with greater disclosure about the underlying assets being securitized. 2 Defects in Risk Management: Thanks in large part to agency and other incentive problems, there was universal underestimation of risks by mortgage originators and financial institutions throughout the securitization chain. Changing incentive pay structures is part of the solution, and so are better accounting rules for SPEs. But more effective regulatory oversight and ending “too big to fail” may well be the only way to curb excessive private risk‐taking. 3 Defects in Government Policy and Regulation: While acknowledging the need for more effective oversight, the author argues that there was ample existing authority for U.S. regulators to have addressed these issues. Lack of power and authority to regulate was not at the heart of the problem—the real problem was lack of foresight and judgment about the unexpected. After expressing doubt that regulators can prevent major financial failures, the author recommends greater attention to devising better methods of resolving such failures when they occur. One of the main goals is to ensure that losses are borne not by taxpayers but by private investors in a way that maintains incentives for market discipline while limiting spillover costs to the entire system.

Date: 2010
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://doi.org/10.1111/j.1745-6622.2010.00285.x

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:jacrfn:v:22:y:2010:i:3:p:22-29

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=1078-1196

Access Statistics for this article

Journal of Applied Corporate Finance is currently edited by Donald H. Chew Jr.

More articles in Journal of Applied Corporate Finance from Morgan Stanley
Bibliographic data for series maintained by Wiley Content Delivery ().