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Abstract

What were the market and regulatory issues that led to the subprime crisis? How should prudential regulation be fixed? The answers depend on the interpretive lenses – or ‘paradigms’– through which one sees finance. The agency paradigm, which has dominated recent regulatory policy and provides the most popular interpretation of the crisis, seems to be influencing much of the emerging reform agenda. But collective welfare failures (particularly externalities) and collective cognition failures (particularly mood swings) were as important, if not more so, in driving the crisis. These three paradigms should therefore be integrated into a more balanced policy agenda. But doing so will be difficult because they often have inconsistent policy implications.