Keynote Address: Understanding the Subprime Financial Crisis

Abstract

This short and accessible paper, based on a keynote speech for a law review symposium, addresses how and why the financial crisis occurred and what should be done to avoid future crises. Among other things, the paper explains why neither the making of subprime mortgages nor the originate-and-distribute model pursuant to which these mortgages were monetized was per se evil; why the governmental regulatory structure failed to deter the crisis; and why the governmental bailout plan under the Emergency Economic Stabilization Act is critically needed and where it may be deficient. The paper also explains the difficulties in valuing mortgage-backed securities and in locating the ultimate holders of risk under credit default swaps and the relationship between financial market breakdown and counterparty risk.