Global Financial Crisis and Ramifications and Impacts upon Ethics and Development of Ethical Behavior - Research Paper Example

? Email Address: Mobile Phone Number: ID Section/# Global Financial Crisis and the Ramifications and Impacts upon Ethics and the Development of Ethical Behavior Table of Contents I. Introduction II. Background and Analysis of Causal Factors and Precipitators III. Ethical Behavior and Standards Prior to the Crash IV. Can Ethics be Fixed V. Conclusion Introduction: As a primary function of understanding the fundamental issues that contributed and aided the global economic meltdown of 2007-2008, one must first look to the housing crisis that precipitated it. As such, this brief paper will analyze some of the ways in which this researcher believes it could have ultimately been prevented, the means whereby ethical standards were violated. Although it is oftentimes noted that hindsight is 20/20, it is worth discussing these mechanisms as a function of gaining a further insight into the way that the market works and seeking to prevent a similar situation occurring within the future. Due to the high level of understanding that current economists have with regards to the Great Depression, many forms of protection have been placed within the current economy as a means of ensuring that the same type of catastrophe, based on the same causal factors, does not occur within the current market. However, these forms of protection were not always present and it can be effectively argued that these were some of the main reasons why the crisis itself was able to be perpetuated and had such long and damaging effects. Finally, as a function of understanding the crisis, what precipitated it, and what furthered it, this analysis will devote a degree of time to analyzing behavioral bias that existed within the system. Background and Analysis of Causal Factors and Precipitators: As such, it is necessary to know, understand, and discuss the forces which could have prevented or at least greatly assuaged the crisis as it has been presented to the financial markets and subsequent global economies over the period of the past 5 years time. In this way, such an exploratory look into the realm of the financial crisis and its subsequent aftermath can allow for a more informed understanding of how the crisis itself could have been prevented as well as the formulation and creation of new and insightful ideas within the reader with regards to how such a situation might be stopped in the future. The first aspect of anticipation and reduction to the crisis came as early as the mid to late 1990s when a number of lawmakers and political analysts began to make a series of warnings concerning the untenable nature of the ways in which the financial sector was being deregulated (Liang, 354).1 Although this deregulation has been attributed to both sides of the political spectrum, in all fairness it can be assumed from a moderate interpretation that both sides were complicit in the wholesale deregulation of the financial sector which ultimately caused the collapse of the real estate bubble (The Banking Crisis 9).2 Moreover, the first real and measurable signs of impending difficulties on the horizon were first demonstrated around the year 2006 when the Department of Commerce noted that new home permits had dropped an astounding 28% (Hsu 497).3 Normally incremental increases and/or decrease in the reduction or expansion of new home permits are little cause for alarm; however, when something as earth shattering and innately odd as nearly a 1/3 reduction in the demand for housing should have been a major red flag to the Federal Reserve as well as the entire regulatory system. However, rather than heed such a statistic, the Federal Reserve remained unrealistically optimistic regarding how the economy would likely behave over the next several months and years (Horner 33).4 This allowed for the current situation to continue to extend itself for approximately another 2 years time before the final result of such a failure in oversight and monetary policy was noted by the stock market in the painful round of shocks that exhibited themselves throughout the stock market and economy during 2008 and 2009. Ultimately, the Federal Reserve felt that even though the drop in applications was something of an “anomaly”, the strong employment figures that the economy was continuing to generate were indicative of the fact that increased consumer spending, and low inflation would help to cover and shortfalls that such an externality may have on the economic system as a whole. Unfortunately, this was not the only sign of distress that the economy exhibited prior to 2008. Economists today point to what is collectively known as an inverted yield curve; utilized to predict the recessions of 1981, 1991, as well as 2000. This inverted yield curve is ultimately something that can be understood from the way that Treasury notes are higher than their long term yields. In a typical situation, long term yields are higher as a result of the fact that investors demand and expect a higher return for investing money for such a long period of time within a certain economic mechanism. Yet, as individuals believe the economy is cooling, the rate at which they will seek to invest in long-term investments as a means of hedging bets with regards to the rigidity of the system exponentially increases (Lian 355).5 Again, the Federal Reserve ignored this implication and assumed that due to the fact that interest rates were low that there was a very large amount of liquidity left to continue to provide for high levels of growth. However, as would soon be seen, liquidity exhibited itself to be the fundamental shortcoming of the entire system. As a direct result of the fact that more and more money was being tied up in long-term investments that were hedging themselves against a very difficult path ahead for the economy, the overall level of liquidity that economists and the Federal Reserve expected was not there to back up anticipation. Another fundamental oversight and behavioral determinant that caused and prolonged the crisis is invariably that of the manner in which the Federal Reserve and shareholders within the banks and financial institutions had an over-reliance on the rapid change that a change in the Federal funds rate could achieve (Bogle 19).6 Whereas many times previously slight manipulations in the Federal funds rate had effected an overnight change in the way that the economy operated and integrated with the news, there remained a diminishing return and an eventual point at which further reduction of the Federal funds rate could affect little if anything to stem to overall loss of confidence and lack of liquidity that was extant within the system (Watson 1528).7 Although the issues that have thus far been discussed tangentially revolve around an understanding of the economy and the way in which the Federal government seeks to integrate with its role of stimulating and forecasting economic development and growth, the next section of this essay will focus upon the role that an unregulated mortgage and banking sector played in adding to an already perfect storm that had been brewing within the market for a period of several years.8 As such, it cannot be understood that any one single culprit is ultimately responsible for the financial collapse of 2008-2009; rather, a litany of factors, many compounding one another, continued to stack up until the point that they were not only providing a definitive strain upon the system, they also served to coalesce and combine in order to send shock waves throughout the global financial system (Death and Resurrection on Wall Street 6).9 One of the ways in which this lack of regulation played into creating, sustaining, and developing the crisis was the sub-prime mortgage market and its general lack of oversight. Many on the far right have blamed the Dodd Frank Act for the crisis; however, seeking to blame the Dodd Frank Act for the economic collapse of 2008 is a gross oversimplification due to the fact that it was both the government itself as well as the financial institutions that failed entirely to uphold any rigid form of oversight into how these loans were dispersed, backed, repackaged, and sold within the market (Freeman 171).10 Perhaps most importantly of all the aspects that have thus far been discussed is the role that MBS (mortgage backed securities) played with regards to the financial crash. MBS were ultimately bundled and sold as a means of generating income by leveraging assets. These high risk bundles were snapped up by willing investors when the market was booming; however, once it began to crumble, few if anyone truly understood what percentage of “bad mortgages” were constituted within the MBSs that were being bought and sold; thereby leading to a fundamental breakdown and/or lack of trust within the system (Singala et al 46).11 Just as was the case during the Great Depression, the lack of trust further served to rob the system of integrity and trust. As a function of the fact that the MBS transactions were spread so evenly throughout the economy, both intra bank as well as personal investment tools, they commanded a heavy price when trust in such a tool began to fail. Moreover, due to the very nature of these transactions, the SEC was not involved whatsoever in regulating their sale (Zhony 81).12 Ethical Behavior and Standards Prior to the Crash: As has already been discussed, the collapse of the United States lending apparatus was precipitated by the collapse of the sub-prime mortgage bubble. Though each of these terms have been discussed with so much frequency and regularity, they tend to lose the original purpose and intent, it is necessary for the reader to seek to place an ethical understanding around the means by which the sub-prime lending situation can be understood. The first issue that necessarily comes to mind is the dishonest and otherwise deceptive means by which the lenders would integrate with the individuals who sought to take these sub-prime mortgages (Ick 87).13 As a function of the fact that the funds behind these sub-prime mortgages were ultimately secured by a complex web of financial institutions and banks and investors, the individual mortgage broker had little if any personal interest in whether or not the loan was able to be paid off by borrower. This represents a fundamental ethical breakdown due to the fact that the lender is no longer interested in the ability of the borrower to pay their loans back and continue to secure the house that they have chosen to reside; rather, the lenders are becoming more and more focused upon filling out as many applications and getting as many signatures as they can receive on a daily basis in order to ensure that they meet their quota and can impress their superiors within the bank or lending institution in question (Houtart 7).14 Likewise, a secondary level of ethical standards that were obviously violated within the given context was the level to which the lending sector performed a practice of what has been deemed “predatory lending”. As such, this represents a process whereby the shareholders within the financial institution would engage in two distinct behavioral practices. The first of these would be to encourage people to take out a mortgage that their collateral assets and income ratio could not hope to afford. Likewise, the second would be to seek to leverage the highest ratio of debt that was allowed by the banking and financial institution on each and every loan that was made. In this way, the lending entities would seek to interest shareholders in houses that the banking employees knew full well they would not be able to afford (Williams & Martinez 66).15 Yet, although the crisis can be well understood from the perspective of how the banks at the very lowest levels integrated with the individuals, this is but one aspect of how the entire Ponzi scheme worked (Fahlenbrach et al 2319).16 In order for such a situation to continue to be viable, it was necessary for the rating agencies and oversight bodies that sought to determine the solidity of these lending institutions fudge the numbers. This was accomplished for years in two distinct ways. It will not be the purpose of this research to state the each and every rating company was crooked and worked in cooperation with the larger financial institutions to make the picture that was presented within their reports to appear as if it were better than in actuality; however, the fact of the matter is that subsequent audits and governmental inquiries have found that a large degree of collusion existed between the rating agencies and the firms that they sought to measure. However, a far greater issue that has been shown to have existed is the fact that the financial institutions and lending and/or banking organizations actively sought to conceal the levels of bad debt that they held on their books. It is at this particular juncture that it should be made very clear that debt in and of itself is an asset that these firms sought to promote; yet, bad debt is a net liability due to the fact that it represents the distinct possibility that the firm will not be able to recover the investment over time as the consumer will be unable to pay the loan off. At this stage, it was the responsibility of the lending institutions and/or banks to be upfront and honest with their investors and shareholders with regards to specifically what percentage of their loans could be classified as “bad debt”. However, due to the fact that honesty in this regard would necessarily decrease consumer confidence as well as the rating that the firms would receive and/or stock price valuation, many chose to engage in otherwise dishonest manipulations of accounting figures in order to achieve the result that was desired. This created something of a vicious cycle where the banks and financial institutions at their highest levels were concealing figures each and every year as a means of presenting a brighter image than was actual reality to the rating agencies that could deeply and profoundly affect their profits and overall presence within the market. Can Ethics Be Fixed? As a function of the issues which have been elaborated on within this research piece, the reader can come to an understanding that breakdowns at almost every level have helped to precipitate the crisis that continues to plague the financial system as well as the major economic systems of the world. However, rather than merely being concentric upon the issues that have helped to place the economy in the present situation, the final section of this analysis will seek to answer the question of whether the ethical and behavioral issues that have thus far been represented can be fixed. With regards to the ethical situations represented by the manner and extent to which the employees of the financial institutions actively and willingly preyed upon those individuals within the home mortgage market that could not afford the mortgages that were being sold to them, the answer is a resounding yes (Cascio & Cappelli 49).17 Changes to the checks and balances as well as oversights that the banking industry now engages upon to clear mortgages prior to them being approved. Secondly, further levels of oversight have now been engaged with regards to the manner in which rating agencies judge debt and the way in which firms report debt (Curtis et al 68).18 Yet, even though both of these factors may have new oversight and new directives with regards to the means by which business should be conducted, this should not been seen as any type of an indication of the fact that ethical standards will now be employed. Ultimately, a fundamental lack of ethical resolve is transmitted via an institution; usually, from the very top (Boatwright 711).19 Once such a rot is able to pervade to the various segments within the institution or firm, few levels of oversight or checks and balances can stem such a rot from affecting the entire firm and the means by which business is conducted. Similarly, with regards to the behavioral determinants which have been listed that are believed to have contributed to the situation, few of these have changed. As a function of the fact that these behavioral determinants are heavily dependent upon the means by which institutional change can be effected, it is not surprising that these have not experienced a greater level of change to date (Vermaelen 83).20 Rather than stating that either the behavioral or ethical standards that precipitated the crisis have not been abated and can be expected to have a noticeable change upon the industry, this analysis would judge the overall effect to be much lower. Although changes have been implemented and it is likely that an exact repeat of the causal factors which led to the crash will be unlikely to be evidenced in very much the same way again, the same underlying ethical issues nonetheless underlie the financial system. Conclusion: Ultimately, the breakdown in the financial system can be defined as the responsibility of the mortgage brokers who made the bad loans as well as the hedge funds who too heavily leveraged the financial instruments that were derivatives of these loans. Moreover, a third culpable party remains the federal government as it ultimately and completely failed in its mission of oversight and regulation of key financial transactions and markets. Ultimately, an ounce of prevention would have been worth a ton of cure and the painful period that the United States and the world economy has faced in the intervening 5 years since the crash may well have been partially averted or lessened. As a function of understanding the way in which the crash was ultimately precipitated, it is the hope of this author that the reader will be more able to provide thoughtful insight into both explaining the key causal factors as well as seeking to prevent such an incident from occurring again. 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