David's analogy is basically sound, I think. As to how it "got started" (which a commenter asked), I think there is some path-dependency at work here in law that is different from other scholarly fields. Most law reviews got started as offshoots of state-based law schools. The Alabama or Missouri Law Review (or wherever) existed to publish articles on developments in the state's laws. The students were going to practice in those states. The article selection process was not really competitive. It was not illogical to have the students edit the articles which were essentially extended case comments, not disquisitions on Habermas or amateur empirical studies. Students can read cases and figure out what the professor is saying about them. Students cannot competently read and judge most of the "major" scholarship that is produced today. I'm sorry, but they just can't.
What I think we have today is path-dependency imposed by what amounts to a cartel model of the law review market. The professors at "elite" law schools look at publishing in "elite" journals as a valuable signal because, well, those journal publish their work and the work of their buddies so they assume that those law reviews must know what they are doing. And the article selection process is a signalling model as well--students, who are unable to discern quality directly because they know so little, instead have to fall back on a signalling model of quality, namely the prestige of the author's institution.
So what we end up with is a circularity--students look to the prestige of the law school as a signal of quality of the article, and in turn, those schools look at the prestige of the publication as a signal for the quality of article.
This also contributes to the frequent boom-and-bust cycles of legal scholarship, where an idea becomes hot for no obvious reason, other than that someone "important" thinks it is important, so everyone talks about it and since all the important people talk about it the law reviews think it is important and so they publish articles on it. Until it is recognized that the ideas are typical law professor hand-waving with no real-world relevance or serious empirical support and it eventually drifts off.
It is a silly, indefensible system, as most cartels are. It does create market opportunities for some schools to actually look at the actual quality of a person's work rather than the trendiness or useless signalling value of placements.
But will it be seriously reformed in coming years? It is not obvious to me that this is an unsustainable cartel, at least for the foreseeable future. After all, it turns out that "reputation" is itself is based largely a signalling model too. So it is not obvious where the incentive to reform the system will come from.
True, because of the way they work, law reviews are laughing-stocks in the academy at large. I've never heard a scholar in another field opine that she wished that their journals were more like law reviews. I've published in at least 5 economics journals that I can think of, and it is simply a superior system (without even getting into the nitty-gritty of peer review versus non-peer review). But it is not obvious that being thought of as a laughing-stock in the larger academy will provide an incentive to reform the system which seems to be largely self-contained and insulated from meaningful competition. So while I share David's aspiration for the emergence of a better system I'm not sure that I share his optimism.