Keywords: theory of the firm, principal agent, banking, financial crisis, USA, United States, sub-prime lending, mortgage loans, originate-to-distribute
The banking firm: theoretical principles and their violations in the USA
The purpose of this paper is to describe a simplified model of the banking firm and contrast its theoretical principles against data from the recent financial crisis especially as it relates to sub-prime lending in the USA. The model presented does not include all aspects of lending; it primarily focuses on 'originate-to-distribute' mortgage loans to the exclusion of other. The proposed theory of the banking firm and the comparison of its principles against performance data may serve as a guide to reforming lending institutions in the wake of the recent financial crisis. The paper contributes, primarily, to pedagogy: it proposes a simplified theory of the banking firm which captures the bare essentials of banking. Additionally, it points-out that the 'originate-to-distribute' banking malaise was one of the drivers of the recent financial crisis but not its root cause.