The Regulatory Interventions Undertaken after the US Post 2008 Crisis - Term Paper Example

Sur Lecturer The regulatory interventions undertaken after the US post 2008 crisis Table of content 0 Background of the US 2008 financial crisis…………………………….3 1.1 Brief explanation of the causes………………………………….3 1.2 Brief explanation of the effects…………………………………4 2.0 Causes of the US 2008 financial crisis………………………………….5 2.1 Contribution of the financial industry………………………….5 2.1.1 The housing crash…………………………………..6 2.1.2 Financial instrument’s web…………………………7 2.2 United States Housing Industry………………………….…..…8 2.2.1 Formation of the housing bubble……………………9 2.2.2 Collapse of the bubble………………………………10 2.3 Financial Crisis and related Theories of Ethics…………………11 2.3.1 Virtue Theory……………………………………….11 2.3.2 Stakeholder Theory………………………………….11 2.3.3 Egoism Theory………………………………………12 2.3.4 Value Maximization…………………………………13 2.3.5 Short-termism Benefit Theory………………………13 Conclusion………………………………………………………………..…13 Works Cited…………………………………………………………………15 FINANCIAL CRISIS IN US 2008 BACKGROUND OF THE US 2008 FINANCIAL CRISIS The United States financial crisis expressively impacted on the world. United States of America is basically in control of the world and financial crisis that took place due to the decline in moral values specifically the economic and political power. In the second half of 2008, the financial markets of the United States, and ultimately all main financial markets of the world, were distraught by the repercussions of the unethical practices of lending carried out by the major lending institutions1. The unethical loans were conducted at the height of the bubble real estate in the U.S. Aggressive and destructive lenders engaged in sub-prime mortgage loans. These were extremely high risk mortgages and most of them were found in the violation of the standards of traditional underwriting practice for the industry. Ethics and prudence were ignored and greed dominated the ethical judgment among nationwide mortgage lenders. This problem was entirely aggravated by leveraging and packaging of such loans by the financial companies of the Wall Street2. Brief explanation of the causes of financial crisis Ideally, the financial crisis in the United States and eventually the whole world was as a result of unethical lenders. The government intervention, ratings agency and borrowers may also be drawn as reasons for the financial crisis problem from ethical perspective. The Wall Street financial companies leveraged the bad loans and had them sold to the unsuspicious borrowers and buyers as a bundled investment in the market. There were various implications of this practice to the real estate market of the United States. For example, when the real estate market eventually began a protracted and severe correction of the market fair values because of the sub-prime mortgage loans given to the questionable borrowers, the United States real estate markets collapsed and the entire situation led to a domino effect that resulted into the collapse and fall down of the major banks as well as a protracted and precipitous drop in insurers, market stock values, financial companies, and ultimately the world’s largest financial crisis after the great depression3. Brief explanation of the effects of financial crisis The findings from the financial crisis were very gross and impacted negatively on the world economy. For example, there were significant financial losses estimated in billions, large companies achieving resounding fails, increased government debt and rising unemployment, and a significant decline in economic activity. In addition, millions of jobs were lost by people, many lost their life time savings and earnings, and many dreams shuttered. This shock took almost two years to be addressed. Although the impacts of the then emerging economies like India and China were minimal, they were not insulated from the crisis due to the infinite connectivity of the whole world4. CAUSES OF THE US 2008 FINANCIAL CRISIS The US 2008 financial crisis were basically caused by numerous factors among them being: the complex nature of the involved financial instruments, the greed of the capital gains in investors, greed of more money in the Wall Street, lack of and inadequate measures of financial controls by the United States Federal Bank, huge and fat salaries of the Wall Street, Lack of moral and ethical values, and short term mentality and self interest. Questions were raised especially concerning the role of the apple in the eyes of and blue eyed graduates from the Wall Street Business School in the entire saga5. Their intelligence and capabilities got questioned. In spite of the much that have been said about the crisis, very little have been done in order to deal with the ethical failure. In order to deal with the ethical failure and find solutions to the whole financial crisis problem resulting from the unethical lending practices, government need to intervene through doing things such as: balancing between the layers of the society, restoring the economic activity, and confirm the social responsibility of the rich against the poor. I believe that unethical decision making and moral degradation was the primary and in fact the prime reason behind the financial crisis. There is therefore need for alternative solution where the pillars will be moral decision making, ethics and integrity6. CONTRIBUTION OF THE FINANCIAL INDUSTRY Much has been said about the contribution of the financial industry to the US 2008 financial crisis with respect to financial context of the whole crisis. However, the ethical angle has not been emphasized, while the unethical process of decision making and moral degradation was the prime reason for this crisis. The financial industry majorly contributed a major crisis, a situation where all the money in the financial markets appeared to be kept somewhere, and a credit crunch, a situation where the financial institution becomes chary of giving credit to each other and other corporations as they perceive high risks in providing credit resulting into the rise in the levels of interest in the whole economy. The companies could not access money needed to support their activities. The US 2008 financial crisis was particularly initiated by the sub-prime lending. People who had mortgaged defaulted payment as the collaterals provided on housing went bad. As the credit rating went bad, people never had adequate income to repay. Eventually, the defaults went up exponentially and the bubble burst taking the banks and the entire economy with it. This led to the fall of the Wall Street institution ultimately7. The housing crash The housing market boom was fueled by the low rates of interest and the huge foreign funds inflow which brought about credit conditions of the period before the financial crisis and also encouraged the consumption that was financed by debt. The home ownership in the United States increased from 64 percent in 1994 to 69.2 percent in 2004. As indicated earlier, sub-prime lending was the primary cause of the increase in rates of home ownership and the general housing demand, which heightened the prices. The housing bubble emerged in some few homeowners who refinanced their homes at lower rates of interests and financing the spending by consumer through removing some mortgages that were secured by the appreciation of the price8. The consumers were both spending and borrowing more even though they were saving less while the housing crunch was heightening. Housing debt experienced a rapid increase during the financial crisis. In the 2008 financial crisis, the typical households in the United States owned 13 credit cards, with about 40 percent of the households making a balance increase from the 6 percent in 1970. The housing prices averaged declined by 2008 September by above 20 percent from the peak in the mid 2006. The unexpected and major housing prices decline inferred that the borrowers had negative equity or zero equity in their homes; this means that the homes were value less compared to their mortgages. By around March 2008, 10.8 percent of all the homeowners, about 8.8 million borrowers had zero or negative equity in their own homes. This had risen to over 12 million at around November 20089. Financial instrument’s web The financial instrument’s web had an enormous contribution to the US 2008 financial crisis resulting into numerous effects relating from the real gross domestic product to distribution of wealth in the United States and to the official economic projections. The financial instrument’s web contributed to the output of services and goods being produced by labor the United States property. The production of such services and goods experienced a rapid decrease of about 6 percent annual rate in the 2008’s fourth quarter and the 2009 first quarter. The rate of unemployment in the United States increased to about 10.1 percent by around 2009 October, this was practically the highest unemployment rate since 1983 and approximately double the rate before the US 2008 financial crisis. The estimated work hours per week reduced to 33. This was the lowest level since the collection of data by the government in 196410. The financial instrument’s web in its contribution to the US 2008 financial crisis, the typical families in the United States did not fare well, neither did the wealthy American families who fell beneath the top of the pyramids. On the contrary, the wealth of about 50 percent of the poorest American families did not decline at all. The Federal Reserve, between 2007 and 2009 surveyed 4000 households. The Federal Reserve found out that the whole wealth of about 63 percent of all the citizens of the United States declined over that period. About 77 percent of the American richest families experienced a decrease in their entire wealth, while just an estimated 50 percent of the American families falling at the bottom of the pyramid experienced the decline in wealth11. UNITED STATES HOUSING INDUSTRY The housing industry experienced a huge decline in worth and value due to the US 2008 financial crisis. This led to the formation of housing bubble and eventually the collapse of the bubble. The housing bubble emerged in some few homeowners who refinanced their homes at lower rates of interests and financing the spending by consumer through removing some mortgages that were secured by the appreciation of the price. Sub-prime lending was the primary cause of the increase in rates of home ownership and the general housing demand, which heightened the prices12. Formation of the housing bubble The formation of the housing bubble resulted due to the prices of houses that rapidly increased as consumers borrowed and spent more while saving less. The debt of housing significantly grew at yearend 1974 from $705 billion, making a 64 percent of the disposable income, to $7.4 trillion at the end of 2000, and finally to $14.5 trillion at the end of 2008. This $14.5 trillion in 2008 made about 134 percent of the disposable personal income. The housing bubble was inevitable. The free cash that the consumers used from the extraction of home equity increased from $627 billion in the year 2001 to about $1,428 billion in 2005. The housing bubble built a whole of about $5 trillion dollars in the period. The debt of the United States home mortgage relative to the gross domestic product increased to 73 percent in 2008 from about 46 percent in the 1990s, reaching about $10.5 trillion. The United States debt of the mortgage doubled between 2001 and 2007. The total amount of debt of mortgage of every household increased by about 63 percent, to $149,500 from $91,500, with fundamentally torpid wages13. This explosion of house prices and credit led to a building boom and ultimately surplus of unsold homes, causing the housing prices in the United States to peak and begin reducing in mid-2006. The belief that the prices of houses would appreciate and the easy credit motivated the subprime borrowers to get adjustable mortgage rates. The mortgages inveigled the borrowers with a low rate of market interest for some prearranged period of time and then followed by the rates of the market for the remainder of the term of the mortgage14. Collapse of the bubble The housing bubble burst between 2006 and 2007 when the housing prices fell downward in the Sunbelt. Several homeowners and speculators were unable to meet their payments, particularly the ones who had the sub-prime mortgages since their personal income was too low to cater for the payments of the eventual month, and those who had adjustable mortgage rates where the payments of the month started low and escalated. With the prices of houses falling, the foreclosures skyrocketed and few people took a risk to buy new houses, since the houses would be worthless sooner than the actual paid price. The construction firms had by this time built millions of homes that were not able to be sold but glutted the market. Construction firms had built millions of new houses that could not be sold but which exceeded the demand in the market. By late 2008 during the financial crisis, about 50 percent of the houses sales in the United States were done through banks which had at low prices foreclosed15. FINANCIAL CRISIS AND RELATED THEORIES OF ETHICS Virtue Theory According to the Virtue theory, the basis of morality is in the establishment of good character traits as qualities: an individual person would be referred to as good if such a person has virtues. The ethics of virtue is fundamentally in line with the virtues of character that are requisite to human flourishing, not with the responsibility listing. Virtue theory is regarded as one of three most important Normative Ethics theory. This theory asserts that our behavior bad or good are not validated by our actions, but by our innate virtues describe the ethical behavior of being. It is important to note that the focus and emphasis on duties and rights is not the centre of the theory of virtue16. Therefore, there is a set of values that people need to ensure their societal well being and in the creation of the ethical world. In the US 2008 crisis, the banks were right if we only mull the other normative ethics theory. They adhered to the government regulations and were operating in the capitalism skeleton. The banks did not however show the virtue that demonstrated ethical conduct17. Stakeholder Theory The Stakeholder theory states that it is the company’s moral responsibility to balance interest of all the stakeholders. This theory demands the knowledge of the role and motivation of all the involved stakeholders in the financial crisis. Banks played an essential role in lending out the money to people and considered their worthiness of credit and through making risky investment hoping that they will recover the funds through selling out the collateral about the same value of the property for which they lent out to the customer. Assuming the possibility of the bubble bursting, the banks established special schemes for the borrowers who had low ratings of the credit in order to ensure the get the loan at higher rates18. Customers were to blame since they got the loan while they could not repay, the customers wanted to enjoy the wave of the housing boom. The shareholders got bothered by the robust returns. They never wanted to dash the growth through putting in the rugged systems. The government also failed to regulate the whole systems to avoid crushing. They did not put in place systems to check the risky financial practices. The agencies for credit rating misled people to believe that the foreign fund products are safe and even gave out positive ratings19. Egoism Theory The theory of Egoism is the foundation of capitalism. This theory asserts that all the actions of every person are based on their own self interest. The impact of egoism theory in the financial crisis is noteworthy. Everyone involved in the US 2008 crisis acted in their own selfish interest: to gain the benefits. The banks wanted to maximize their revenues and profits, customers intended to get capital gains from the banks, insurers wanted to gain premiums, and credit rating agencies wanted to boost their reputation in the market and profits. Generally, everyone wanted to get something from the situation, but forgot that it became a zero sum situation. Theory of Value Maximization This theory is founded on the basis that organizational actions exist to maximize its stakeholders’ value. The US 2008 financial crisis was a direct inference of value maximization theory. The intension of the banks was to generate value for everybody. The banks ventured into some practices that could be termed unethical. Albeit in the short run, the banks created value for each participant: Promoter received huge capital gains and dividends, customers got houses, and insurers made huge money. Short-termism Benefit Theory This is the mentality of individuals in the short term with lack of long term vision to establish value. The US financial crisis is an allusion of short term focus. The banks wanted to access the customers in order to save time, the customers wanted to buy the property very fast. Ultimately, everyone was blinded by the quest to earn fast money20. Conclusion In summary, the unethical loans were conducted at the height of the bubble real estate in the U.S. Aggressive and destructive lenders engaged in sub-prime mortgage loans. The requirement to have an alternative business school has been, through providing philosophical justifications and theoretical justification and factual information, established. The prevalent approach of business schools has recent been analyzed in order to find out the significant areas in which the alternate business school should shift their attention. The established alternative business school will be founded on the principles of moral ethics, values, social welfare and integrity. In order to ensure this, several changes will be developed in the approach at hand of the business schools. The alternatively established business school will also ensure that the world does not again suffer because of ethical degradation and excessive greed of elite few. Ethics and prudence were ignored and greed dominated the ethical judgment among nationwide mortgage lenders. This problem was entirely aggravated by leveraging and packaging of such loans by the financial companies of the Wall Street. The United States financial crisis expressively impacted on the world. United States of America is basically in control of the world and financial crisis that took place due to the decline in moral values specifically the economic and political power21. The financial crisis in the United States and eventually the whole world was generally as a result of unethical lenders. The government intervention, ratings agency and borrowers may also be drawn as reasons for the financial crisis problem from ethical perspective. However, more specific causes could be summarized as: the complex nature of the involved financial instruments, the greed of the capital gains in investors, greed of more money in the Wall Street, lack of and inadequate measures of financial controls by the United States Federal Bank, huge and fat salaries of the Wall Street, Lack of moral and ethical values, and short term mentality and self interest22. Works Cited Alexei M. Marcoux. Business Ethics Gone Wrong, New York: McGraw Hill, 2010, 35-49 Andy Blunden, Ethics and why the Financial Crisis is insoluble, New York: SAGE, 2008, 20-31 Arjoon, Surendra, Virtue Theory as a Dynamic Theory of Business. Journal of Business Ethics, 6(4), 2010; 159-178 Baugher, Dan and Weisbord, Ellen. Egoism, Justice, Rights, And Utilitarianism: Student Views Of Classic Ethical Positions In Business. Journal of Academic and Business Ethics, 4(5), 2009; 1-11 Blame Business Schools, Electronics Resource, Retrieved on 22nd April 2013 http://www.businessweek.com/debateroom/archives/2008/11/us_financial_cr.html Boyle, Catherine. Credit crunch: public point finger of blame at greedy banks. Electronics Resource, Retrieved on 22nd April 2013 from http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4432267.ece Brown, Gordon: Beyond the Crash: Overcoming the First Crisis of Globalisation, Simon and Schuster, 2011, 29-65 Business Schools Mull Over Blame, Electronics Resource, Retrieved on 22nd April 2013 from http://www.npr.org/templates/story/story.php?storyId=103719186 Cassidy, John: How Markets Fail: The Logic of Economic Calamities, Allen Lane 2009, 21-34 Cooper, George: The Origin of Financial Crises, Harriman House, 2008, 30-40 How a financial crisis a lesson in Ethics, Electronics Resource, Retrieved on 22nd April 2013 from http://ethicaloptimist.com/2008/10/22/how-the-financial-crisis-is-a-lesson-in-ethics/ Longstaff, Simon. Ethics and Global Financial Crisis, Living Ethics, Vol 9 issue 74, 2008; 19-28 Missing Ethical Angle in Financial Crisis, Electronics Resource, Retrieved on 22nd April from http://www.reuters.com/article/idUSTRE6231H320100304 Morris, Charles: Billion Dollar Meltdown, Perseus Books 2008, 47-51 Orts, Eric W. and Strudler, Alan. The Ethical And Environmental Limits Of Stakeholder Theory. Business Ethics Quarterly, 5(6), 2009, 215-233 Peppers, Don. The Financial Crisis: Short-Termism Coming Home to Roost, Electronics Resource, Retrieved on 22nd April 2013 from http://www.1to1media.com/weblog/2008/10/the_financial_crisis_short-ter.html Phillips Robert. Some key questions about Stakeholder Theory. Ivey Business Journal, 2(7), 2009; 25-31 Scarborough, Jack, The ethical implications of short-termism: Leadership failure in the executive suite, New York: Prentice Hall, 2009; 25-37 Shaw, John. Higher Education Business Schools – Part of The Problem or The Solution? Electronics Resource, Retrieved on 22nd April 2013 from http://www.wcf2009.org/program/down/066_S1-I07-1_John_B_Shaw.doc Who is to Blame for Credit Crunch? Adapted from http://www.economicshelp.org/2008/08/who-is-to-blame-for-credit-crunch.html Read More