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9 J. Corp. L. Stud. 1 (2009)

handle is hein.journals/corplstd9 and id is 1 raw text is: Journal of Corporate Law Studies WHAT WENT WRONG? AN INITIAL INQUIRY INTO THE CAUSES OF THE 2008 FINANCIAL CRISIS JOHN C COFFEE,JR The 2008financial 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-vwhich became increasingly subject to client pressure as competition increased in its market; and (h) a shift toward more self-regulatogy rules that permitted US investment banks to increase leverage and reduce diversification under the pressure of competition. The polic lesson seems clear: competition is not a substitute for regulation, and the caseforprudential regulatory supervision offinancial institutions becomes stronger as the relevant market becomes more competitive. A major financial crisis, originating largely in the United States, has engulfed the world's markets and necessarily focuses our attention on what causes market bubbles. Why did both debt and equity markets decline rapidly and largely uniformly across nations and economies? Any explanation at this stage must be provisional, but regulators worldwide cannot await the long-term verdict of history Thus, this essay will offer an early reading of the evidence, focusing largely on the United States. Financial debacles are much like Tolstoy's unhappy marriages: each is different in its own way But collectively they share at least three critical common denominators. First, market bubbles burst when investors recognize a systematic failure by an institutional actor that this essay will term a gatekeeper. Gatekeepers are reputational intermediaries who provide verification and certification services to investors, doing essentially what investors cannot easily do for themselves.1 Although they may also face legal liability, gatekeepers basically assure investors as to their reliability by pledging a reputational capital that they have developed over many years and many clients so that the investors recognize that no individual corporate client could pay the gatekeeper enough to compensate it fully for the loss of reputational capital that it would suffer from association with * Adolf A Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance. A Fellow of the American Academy of Arts and Sciences, his legal specializations are in securities law, corporate governance, and white collar crime. I For a fuller definition and discussion of this concept, see JC Coffee, Jr, Gatekeepers: The Professions and Corporate Govemance (Oxford University Press, 2006). April 2009

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