What Went Wrong? An Initial Inquiry Into the Causes of the 2008 Financial Crisis

Abstract

The 2008 financial crisis was the direct product of a supply-driven bubble in which a new financial technology (asset-backed securitization) failed. In the US, this failure seems attributable in large measure to two under-recognized causes: (a) excessive reliance on a gatekeeper—the credit rating agency—which became increasingly subject to client pressure as competition increased in its market; and (b) a shift toward more self-regulatory rules that permitted US investment banks to increase leverage and reduce diversification under the pressure of competition. The policy lesson seems clear: competition is not a substitute for regulation, and the case for prudential regulatory supervision of financial institutions becomes stronger as the relevant market becomes more competitive.

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