The Mortgage and Financial Crises: The Role of Credit Risk Management and Corporate Governance

Abstract:     
This paper discusses the role of risk management and corporate governance as causal factors in the onset of the financial crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. We argue that this failure was a result of principal-agent problems internal to the firms and to breakdowns of corporate governance systems designed to overcome these principal-agent problems.

Keywords: Financial Crisis, Risk Management, Corporate Governance, Subprime Crisis

JEL Classification: G01, G18, G21, G28

working papers series