Engineering Economic: 2008 Financial Crisis - Term Paper Example

Engineering Economic: 2008 Financial Crisis The financial system was at its weakest in 2008 resulting to a global financial crisis where it had affected global industries and economies around the world. It also caused a major meltdown on huge financial institutions and led to the fall of the stock market prices (Shah). The aim of this paper is to examine The Global Financial Crisis In 2008. A summary will be provided to bring light on what really occurred between August 2008 and October 2008. Two films, Too Big to Fail and Margin Call will be scrutinized and compared to determine which between the two films depict the real situation. It will also determine any legislation that has been passed to revamp the lending and banking system in response to the global financial crisis. Items that were part of the crisis and legislations passed will be identified to examine on how they impact the profession of Industrial Engineering. Moreover, it will discuss the ethical implications that were elaborated in the financial crisis. Summary on what transpired between August 2008 and October 2008 The global financial crisis started in August 2008 which was brought by several factors such as the slump of huge financial institutions, financial assistance of bankrupt banks by federal governments, and the decline of global stock market. This suffers the housing market which brought an increase of 9.2% of unresolved mortgages, which were either delinquent or facing a termination of property rights (Forrest and Yip 84). On August 2, 2008, carmaker General Motors (GM) declared a loss of $15.5 billion, which is its third largest loss in its entire industrial existence (Ciesielka). On August 4, 2008, HSBC, a large international banking institution, revealed the decline of profits by 28% as a result from the problematic financial market (Guillen 6). On September 15, 2008, Lehman Brothers, an investment bank in Wall Street, had filed for bankruptcy while another financial institution, Merrill Lynch, had been taken over by another bank, the Bank of America, due to insolvency. On September 16, 2013, the United States (US) Federal Reserve lent $85 billion to American International Group (AIG), a multinational insurance company, to save it from bankruptcy (Kingsley). In United Kingdom, Lloyd TSB notified the public with its takeover to HBOS, the largest mortgage lender in the region, on September 17, 2008 (Guillen). On the same month, Washington Mutual and Wachovia, two American banks, became insolvent and were closed down. Due to turbulent situation of credit and stock markets, U.S. Treasury Secretary Henry Paulson introduced the financial rescue plan to provide assistance to financial institutions who had incurred losses as far as $50 billion. On September 29, 2013, the Emergency Economic Stabilization Act was approved by the U.S. Congress. Moreover, it was in this month that the Dow Jones Industrials, a stock market index, had its largest fall on September 29, 2008 (“Timeline of World”). Due to the alarming effects of the financial crisis, the U.S. Senate had submitted HR 1424 which is an amendment of the bailout bill on October 1, 2013. It was on October 3, 2013 that this legislation was approved by the U.S. Congress and signed by former President George W. Law that took effect to take its effect (Davis and Espo). It was during this month that the stock market had hit its all time low for the past 75 years. In order to incorporate liquidity in the financial market, the Internal Revenue Service (IRS) eased out its statutes regarding the repatriation of foreign money by companies (“Timeline of World”). Central banks of several countries, such as U.S., China, and Europe countries, had cut down its interest rates to ease out the burden of borrowers and support the global economy. Yamato Life Insurance Company filed for insolvency, which became the first Japanese firm directly affected with the U.S. mortgage dilemma. As a result from the Economic Stabilization Act, the American government had administered $250 billion to its banking system. The British government had also bailed out its banks from insolvency to prevent a crumble of its banking institutions (Kingsley). Comparison of two films, Too Big to Fail and Margin Call In the movie, Too Big to Fail, its plot centers on the initiatives taken by U.S. Treasury Secretary Henry Paulson to solve the problems between August 2008 and October 2008 regarding the collapse of the financial system. The movie focused on the action done by Paulson to save Lehman Brothers from suffering the same fate with Bear Sterns, down to passing legislation to stabilize the financial system. On the other hand, the movie Margin Call revolves around the employees of an investment firm in the early period of the financial crisis. Although both movies center on the financial crisis, Two Big Fail depicted the true events and characters of the event while Margin Call have fictional characters. The real characters that were represented by the movie, Too Big Fail, include U.S. Treasury Secretary Henry Paulson, the Federal Reserve Chairman Ben Bernanke, and Lehman Brothers Chairman and Chief Executive Officer Richard Fuld. The movie, Too Big to Fail, was commendable in presenting the real accounts of what truly transpired between the periods of August 2008 and October 2008 where the fall of the Lehman Brothers had created a destabilization of the financial system. It was well accounted on how the U.S. government have done nothing to bail out the giant investment bank from bankruptcy as reported in the news headlines (Sorkin), but what was not known by the public was the drama behind the dilemma of Paulson in trying to save the investment bank from crumbling. The movie gave a clear explanation on why they chose to bailout AIG from bankruptcy despite the lack of legislation due to the fact that it is a company that is too large to lose because of the major effects it can bring to the financial stability of the world. Its collapse will also bring major losses to industries around the world where AIG is connected to. This provided a justification on the bailout by the Treasury of AIG which was also reported on the news (Amadeo). Another key event that was presented in the movie during the financial crisis was the passing of the bailout bill which was not paassed by the U.S. Congress for the first time, but was successful in its second attempt when it was rectified to Emergency Economic Stabilization Act of 2008 (“Policy Summary”). On the other hand, the movie Margin Call, centers around fictional employees at an investment bank on the early period of the financial crisis, unlike the movie Too Big to Fail which focused on the critical period of crisis. Although the movie did not present real characters which Too Big to Fail was concern, it provided a reality on how an investment bank had dealt with the crisis before it erupted. Real accounts presented in the movie were how the possession of toxic assets impacts an investment bank. Due to an expected loss and hindsight of bankruptcy, major layoff of employees was imminent (Scott). The movie was more concerned on how the investment bank tried to survive and save the company before the knowledge on how the stock market will behave erratically will be known to the market. It provided awareness on how the volatility of mortgage securities brought the onset of the 2008 financial crisis (“Mortgage -Backed Securities”). While Too Big to Fail presented a larger scene on how the fall of Lehman Brothers had brought to the entire financial system, Margin Call provides a preview on how the crisis will affect the entire market by looking at the focused investment bank. Between the two movies, Too Big to Fail presented a more chronicled accounts on what truly transpired in the 2008 financial crisis, from its cause, effect, and intervention. Legislation To solve the major financial disaster of the 2008 financial crisis, the U.S. Treasury Department headed by Secretary Henry Paulson proposed the Emergency Economic Stabilization Act of 2008. The first proposed legislation was not approved by the U.S. Congress on September 29, 2008, which aimed to procure toxic assets to minimize the anxiety towards the worth of assets from investment banks. The proposal aimed to uplift the confidence level of investors in the debt market. To rectify the rejected proposal, a revision on the original proposal to HR 1424 was implemented by the department as approved by the U.S. Senate on October 1, 2008. The legislation was authorized by the U.S. Congress and signed by former U.S. President George W. Bush on October 3, 2008. It was formulated to address the mortgage crisis which catapulted the financial crisis. This allows the government to intervene and stabilize the crumbling financial system. An estimated $700 billion was budgeted to be used in procuring toxic assets. Specifically, mortgage securities and provide cash funds to investment banks. This allows investment banks to operate normally under the financial crisis (Amadeo). Troubled Asset Relief Program (TARP) was developed by Paulson to manifest this legislation. With the given budget, the Treasury department was allowed to purchase mortgage securities, which obstructed the balance sheets of investment banks. In doing so, investment banks will be free from these toxic assets, thus promoting liquidity and preventing further losses, which gives a solution to the ill financial market. This program does not focus on providing bailouts to domestic banks alone, but had included foreign banks, as well as part of the amended legislation. Although this program did not provide a solution to investment banks in recovering their losses, it aids them in incurring more losses in the future. Another purpose of this program was to allow banks in offering credits to individuals and companies. This uplifts the confidence of banks to the public thus stabilizing the credit market which is another factor in the financial system. In order to encourage more investors in loaning from financial institutions, lower interest rates are implemented (Congressional Budget Office). Financial institutions who wish to participate in the program must be established and had operated under the U.S. constitution. Financial firms who participated in this program are asked to provide equity warrants or securities to the Treasury department for their assets to be procured at a specified price. Warrants benefit the taxpayers when these firms acquire growth in their business in the future. Several financial institutions are already guaranteed to be included in the program, which includes American insurance corporations, American savings banks, and American investment firms. Participating firms are incapacitated to some tax benefit entitlements and have limited executive compensation. It inhibited golden parachutes and required the return of unearned rewards. In order to prevent the waste, embezzlement, and abuse of bailout money, the treasury department appointed an Inspector General to oversee such cases. The financial firms who had the freedom to participate in this program include American Express, Bank of America, and JP Morgan Chase. To end the prevalent control of the government over the operations of participating financial institutions in the program, they have to pay the bailout money in full (Webel). Impact to the profession of Industrial Engineering Falling Stock Market The crumble of the stock market drove all the share prices of industrial companies down to the bottom. This impeded the economic activity of the company. As share prices fall, the imminence of bankruptcy is at hand. Company revenues decreased due to less consumption of goods by customers who are also affected with the crisis. In order to avoid bankruptcy, industrial companies tried to cut their expenses down, thus involving the major layoff of employees. It is the job of industrial engineers to make a head count on the right amount of personnel which are needed to run a production line. Apparently, the responsibility in cutting down a number of employees to conform to the right amount of budget and meet the declining orders from customers rest on the hands of industrial engineers. To make matters worse, since most production companies no longer operate in the business due to unfavorable financial conditions, no employment are also available for them, and some are also laid off from their jobs. TARP This program provided financial aid to firms that are at the brink of bankruptcy. Industrial companies were also encouraged to participate in the program. This gave hope to industrial companies to continue their normal operations in the midst of the financial crisis. This enabled the continuance of employment in respective firms who have applied for this program. This gave an opportunity for industrial engineers to maintain their jobs at their respective companies. As financial institutions were able to operate normally under the given circumstances, it stabilizes the financial system which made the recovery for some industries incur future losses in the business. Loans were also made convenient to industrial investors by giving lower interest rates. This helped industrial companies invest more on projects to recover from their big losses. As more projects are invested more by industrial companies, the profession of industrial engineering became in demand to the employment market because their profession deals with the management with all these projects. Bankruptcy of Investment Banks This condition had frozen some of the assets by industrial companies that have invested their money on these financial institutions. With limited financial means, industrial companies were not able to finance their normal operations efficiently. As investment banks collapse, industrial companies collapsed as well because no financial institutions were existent in providing those funds for operations and projects. This led to major termination of operations, most especially to small companies. As companies can no longer finance their operations, major setbacks on employment were prevalent. More professionals were left unemployed due to this crisis, including industrial engineers, which expertise lie on industrial companies. For existing industrial engineers working under this scenario, this gave a problem in managing the production mechanism without sufficient funds and resources. The profession of industrial engineering is much needed at this time because it is the job of industrial engineers in managing limited resources to make production work usually. Ethical Implications In the early stages of the financial crisis, mortgage brokers cared more in acquiring more clients without thinking of the quality of mortgage the clients will be put into. They do not care whether the customers who had transacted a mortgage deal with another party will be at full risk, especially given the volatility of the mortgage securities in the financial market. They have given in to the temptation in aspiring for more money without thinking of the negative consequences it brings to customers who are unknown of their ill fate in the future. Part of being a professional is a fiduciary duty to protect the interests of the customers (GreyCourt). This duty was not presented in the business with mortgage brokers, which had aggravated the financial crisis to its worst, leaving more people unemployed and homeless. Commercial banks also committed unethical practices in the wake of the financial crisis by approving mortgage loans to people who have low credit ratings, in which they knew that they were not capable to pay. The aim of the banks in doing this practice was to acquire more cash from customers. In order to remove these mortgage securities off their balance sheets, they sold them to innocent investors who have not known on the risk of acquiring these assets. On the other hand, investment banks continued to sell shares at a lower price to investors, when they knew that the values will eventually fall at any given time (GreyCourt). This implies unethical behavior among banks because they have not cared on the negative consequences the investors will be dealing with when these assets no longer have any value at the time of the financial crisis. Organization leaders became impartial in making decisions towards laying off employees to cut costs. Appropriate decisions were not made when they knew that their remuneration and position in the company were at risk. They also became selfish in saving their own sake rather focusing on saving the whole company and its employees (Argandona 5). These behaviors show unethical behavior, which contradicts on its duty in protecting the rights of employees and interests of the shareholders. The U.S. Treasury Department has also been unfair in bailing out other companies, which exclude Lehman Brothers. Although the department had refuted that it was due to the lack of legislation which had impeded them from aiding the investment bank, it did not convince other people because the department had bailed out Bear Sterns when it was facing its brink of bankruptcy without legislation (Sorkin). Treasury Secretary Paulson’s fair judgment was put into scrutiny in this issue because he could have done something to save the investment bank from collapsing which could have alleviated the downfall of the global financial system. His fiduciary duty to protect all financial institutions in his jurisdiction was not exercised fully which became an issue of unethical practice. With this experience, Paulson had learned to step up his decision and legislate a bailout bill to save other companies from facing the same fate with Lehman. This redeemed the reputation of the secretary in the public. Conclusion The aim of this paper is to explore the financial crisis that had crippled the financial system in 2008. A summary of what transpired between August 2008 and October 2008 was presented which discussed on the fall of Lehman Brothers down to the legislation of U.S. Treasury Secretary Paulson on bailing out major companies from bankruptcy and stabilizing the economy. Two movies, Too Big to Fail and Margin Call, were compared in accordance to how they have recounted the true events of the financial crisis and proclaimed Too Big to Fail as more realistic than the latter. The legislation of the Emergency Economic Stabilization Act of 2008 was discussed in this paper. The impact of the downfall of the stock market, the bankruptcy of investment banks, and TARP to the profession of Industrial Engineering was also discussed. Moreover, the ethical implications of some of the practices of mortgage brokers, banks, and Paulson were scrutinized in this paper. Works Cited Argandona, Antonio. Three Ethical Dimensions of the Financial Crisis. 2012. Web. 6 Dec. 2013. Amadeo, Kimberly. “Understanding the AIG Bailout.” About.com. n.d. Web. 6 Dec. 2013. Ciesielka, Wyatt. “Sudden Destruction!” Tomorrow’s World. n.d. Web. 5 Dec. 2013. Congressional Budget Office. “Report on Troubled Asset Relief Program” 23 May 2013. Web. 6 Dec. 2013. 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Scott, John. “Why Toxic Assets are so Hard to Clean Up.” The Wall Street Journal. 21 July 2009. Web. 6 Dec. 2013. Shah, Anup. “Global Financial Crisis.” Global Issues. 24 March 2013. Web. 5 Dec. 2013. Sorkin, Andrew Ross. “What Might Have Been, and the Fall of Lehman.” Dealbook. 9 Sept. 2013. Web. 6 Dec. 2013. “Timeline of World Financial Crisis.” The Telegraph. 23 June 2011. Web. 5 Dec. 2013. Too Big to Fail. Dir. Curtis Hanson. Perf. William Hurt, Edward Asner, Billy Crudup, Paul Giamatti, and Topher Grace. HBO, 2011. Film. Webel, Baird. Troubled Asset Relief Program (TARP): Implementation and Status. 27 June 2013. Web. 6 Dec. 2013. Read More