State of corporate finance it's not over yet.

• Author: Acharya, Viral V.
• Position: CIT Group Inc.

Leaving the Las Vegas strip, after just a few miles of driving on Interstate 15 on the way to Los Angeles, you'll come to the "Blue Diamond Road" exit, which takes you west toward the mountains. Within five miles, you will run into what was at one point the fastest-growing master-plan community in the United States, Mountain's Edge. Intended to hold 12,000-plus homes, along with a network of schools, professional offices, restaurants and neighborhood shops, the community was a model for Las Vegas' growth.

Development started in 2004, with home prices appreciating more than 50 percent per square foot in the following two and a half years. By late 2007, early 2008, however, Mountain's Edge had become a poster child for the troubles of the housing market. With only two-thirds of the homes completed, mega-grocery stores half finished and construction not yet begun on local parks, Mountain's Edge resembles other communities stretching from Stockton, Calif., to Phoenix to Miami.

As an illustration of the problem: In February 2009, 57 homes in the Mountain's Edge community were sold from the lot that had also been sold in 2006, the peak of the "housing bubble." The average drop in price for these homes was 47.9 percent. With homeowners committing very little equity to the underlying values of these homes, almost all of these losses were borne by the creditors.

Who are these creditors? In most cases, they are banks (or more broadly, large and complex financial institutions) that have borne such substantial losses from housing price collapse that either they have collapsed themselves or are on "oxygen" from the federal government.

The key is that the ongoing crisis is not just about fear and illiquidity, but one of fundamentals and insolvency. This point has important implications for U.S. corporations, both small and large. Neither policymakers nor the public at-large realized this was the problem until fairly recently.

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Real Story about the Financial Crisis

The popular version of the financial crisis of 2007-09 had been that securitization without skin in the game led to the issuance of low-quality loans due to undercollateralization and/or lending to poor borrowers. Unsuspecting buyers of these securitized products, in turn, suffered significant investor losses--the type described above with respect to the Mountain's Edge community.

This, in turn, caused investors to lose confidence in the U.S. financial system.

If only this were the case, investor confidence could be regained, for example, with abundant supply of liquidity from the Federal Reserve to financial institutions and back-stopping of losses by the U.S. Treasury. But this has not happened.

That's because it is not just about restoring investor confidence and dispelling their fears. The fact is that securitization did not pass the credit risk from banks onto capital investors. Rather, financial institutions ignored their own business models and held on to the risk by exploiting loopholes in capital regulatory requirements--through the creation of off-balance sheet vehicles that housed these loans; buying protection via credit derivatives from monoline insurance companies and American International Group Inc. and the outright purchase of so-called "super-senior tranche of loan portfolios."

The creditors facing the collapse of home prices in Mountain's Edge and similar communities were not just capital market investors but to a significant extent by the banks themselves.

Analysts who view the crisis as one of illiquidity cite Lehman Brothers Holdings Inc.'s failure last September as evidence that the crisis was mostly about fear. They argue that Lehman's bankruptcy caused paralysis in capital markets and the banking sector, and then this fear spilled over to the economy at-large.

There is little doubt that there have been severe dislocations during this crisis as a result of investor panic and extreme illiquidity in normally, well-functioning markets. But the crisis, initiated in late July 2007, continues to...