INDIVIDUAL ASSIGNMENT Critically discuss the contention that inadequate regulatory oversight in the United States of America combined with a culture of greed within the finance sector led to the global financial crisis of 2008-2009. SUBMITTED BY: PANKAJ PARASHAR STUDENT ID: 3098673 SUBMITTED TO: DR. LISA BARNES GSBS6484:CORPORATE GOVERNANCE AND SOCIAL RESPONSIBILITY PANKAJ PARASHAR 3098673 GSBS6484 Page | 2 TABLE OF CONTENTS 1. EXECUTIVE SUMMARY……………………………………………. 3 2. INTRODUCTION ……………………………………………………… 4 3. GROWING OUT OF FINANCIAL CRISIS…………………………. 4. INITIATION OF GLOBAL FINANCIAL CRISIS…………………. .5 5. CRITICAL ANALYSIS OF US POLICIES AND IRREGULARITIES OF FINANCIAL MARKET……………………………………………6 6. CORPORATE GOVERNANCE PERSPECTIVE OF CRISIS……… 7 7. OTHER GLOBAL MEGATREND RESPONSIBLE FOR CRISIS…8 8. OVERALL ANALYSIS OF US POLICIES & IRREGULARITIES… 9 8. 1. 8. 2. 8. 3. 8. 4. 8. 5. FAILURE TO REGULATE FINANCIAL DERIVATIVES….. 9 UNSUSTAINABLE ECONOMIC BOOM……………………… 10 POOR MONETRAY POLICY………………………………….. 10 EXCESS PRODUCTION OF GOODS…………………………. 11 CASHING IN ON FALLING SHARE PRICE…………………. 11 9.
CONCLUSION………………………………………………………… 11 10. REFERENCES…………………………………………………………12 GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 3 1. EXECUTIVE SUMMARY This report endeavors to support the contention that US unlawful practice and greed in higher authorities were somewhat responsible for the global financial crisis in 2008-2009. Additionally, discussion involves the unethical practices and flaws in both private and public sector, especially intermediaries between investors and borrowers, which were the accountable for this economic crisis.
It also argues about the tendency to blame US, is not the right approach because poor governance practice and loose regulations are worldwide incidents and other countries are equally responsible for a current universal downturn. Later, paper investigates the role of various government policies in the burst of housing and financial bubble and describes how the greed of officials and erroneous banking and financial regulations were the roots of current recession.
This report is trying to expose a number of previously observed, documented but unresolved fragilities within the integrated financial system. GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 4 2. INTRODUCTION Every crisis has its lesson. A global financial and economic convulsion of the degree we have just experienced should offer more lessons than most (Neal, 2009). The effects of their mistakes had a ripple effect on other countries as well, which is said to be the largest socio-politico-economic event in last 65 years(Yeoh, 2010).
The main elements involved in global financial crisis include a dramatic swing in the recent account statements, true depreciation, and a considerable lag in net output(Summers, 2000). The leading approaches to understand the cause of crisis include namely: • Macro-economic, • Accounting –finance and • The legal corporate government position(Yeoh, 2010). 3. Growing out of Global Financial Crisis (GFC): The US economic catastrophe, which has since become global, it mainly originated from 2007 due to poor performance of US mortgage industry(Kregel, 2008). US has followed aggressive economic policy aking, which emphasizing namely on low interest rate, deregulated market (financial) and low tax(Donato, 2009). New financial aura has been created in US financial market by these policies in which money became cheap, positive prediction on housing market instigate financial institutions and home owners to lend and borrow money(Obama, 2009b). Eventually sub-prime lending climbed up whereby a bank lent money to even those with poor credit histories. These irregularities resulted as a burst of housing bubble, which had adversely affected on the global prime market orldwide(Donato, 2009). This report is mainly emphasizing on the origin of the GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 5 GFC lax macroeconomic policies in the context of weak prudential and regulatory oversight, led to excessive leverage, mispricing of risk and build up of systemic risk(Lin, 2009). 4. Initiation of global financial crisis: The entire financial crisis since 1930 has proximity to one another overpriced stocks, trouble-free credit expansion, insatiability of power & money and substantial fraud(Yeoh, 2010).
However, 2008 economic catastrophe resembles that markets are more closely linked to each other and systemic risk can be originated from many market resources and can be transferred very quickly due to lack of proper corrective measures(Kindleberger et al. , 2005). The crisis mainly begun in January 2007, when US market reported losses in mortgage market and credit exposure due to certain delinquencies, especially in sub prime loan category. Stage 2 of crisis came up with fast deflation of housing value in slowing world economy, and it damaged property market in UK and Eurozone.
Northern Rock one of the most renowned UK mortgage bank collapsed because of the knock on effect of US mortgage bubble bursting1(Gerson LehmanGroup, 2009). Aftermath NR collapse the banking credit spreads2 reached over 175 points for AA-rating companies. This showed the way of entire shutdown of asset securitization3 markets. Stage four of the crisis begun in September 2008 1 Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically haracterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in a position of negative equity—a mortgage debt higher than the value of the property. 2 3 The risk premium paid by banks and other financial institutions over the cost of funds paid by the government Asset securitization capital market where mortgages, credit card balances, and other types of loans are packaged nto securities GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 6 when many US financial institutions that dealt with the US housing finance market bailed out by US government(Yeoh, 2010). For example Washington Mutual Bank, Us financing agencies like Fannie Mae and Freddie Mac, invest bank Lehman Bros and then AIG insurance group(Gerson LehmanGroup, 2009). US financial authorities failed to give the kiss of life to Lehman Bros. which was the key link between the securitization market and mortgage banker, US insurance and housing financing industry.
The collapse of Lehman Bros gripped whole US market into trouble(Coffee, 2009). 5. Critical analysis of US policies and irregularities of financial market: The reasons behind the precipitation of crisis in US are as follows: • Bad money policy of a deflated dollar to promote public and private debts • The extension of the banking and finance service sector through offensive (abusive) adaptation of risky financial innovation and irresponsible behavior in shadow banking system4 • Interrelation of home rights with global credit insecurity/instability (Phillips, 2008)
In the early 2000, US federal placed many policies to undervalue risk in the subprime mortgage market. • Loose Fed interest rate policy (2000-2005), provided low interest rate for a constant period. This resulted in overpricing of houses due to flexible monetary policies, which supported the housing market with cheap excessive credit(Yeoh, 2010, Donato, 2009). The shadow banking system or the shadow financial system consists of non-bank financial institutions that play an increasingly critical role in lending businesses the money necessary to operate.
GSBS6484-Corporate Governance and Social Responsibility 3098673 4 Page | 7 • These policies also promoted high risk culture in various financial institutions. For example, Federal pressure has been places on government supported enterprises like Fannie Mae to provide housing access to underclassed by investing in highly risky sub prime mortgages and offer them various lending policies as well(Yeoh, 2010). • The restrictions placed on bank stock purchases for the institutional shareholders. So many corporate leaders then promote the short term interest of stockholders by manipulating compensation packages.
Many irregularities in financial policies like withdrawn of Glass-Stegall act and FABS & SEC5 provided ambiguous policies for the regular use of Off-balance sheet accounting6 and careless financial culture(Kregel, 2008, Yeoh, 2010). • The unethical practices of Gatekeepers in the US market cause this financial catastrophe. Gatekeepers’ word here refers to the renowned intermediaries that verify or certify financial documents to investors. This may include auditors, debt rating agencies, security analysts and investment bankers.
They have been engaging into the unethical activity which gave the big loss to the company by showing inflated financial status of the company(Yeoh, 2010). 6. Corporate Governance Perspective of crisis: Corporate governance issues in US also argue about the flaw associated with the processes and law governing which accounts for the financial crisis. The monetary catastrophe is an important attributed of failure and weaknesses in corporate governance, which was not able to provide protection against proliferated risk in the financial market(Lin, 2009).
Failure of corporate governance, in US results in global capital imbalance, loose monetary policies & weak regulatory oversight. For 5 6 FASB- Financial Accounting standard board & SEC- Securities and Exchange Commission. Off balance sheet (OBS) usually means an asset or debt or financing activity not on the company’s balance sheet. GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 8 instance, at Bear Stearns higher management lost over the USD 1. 4 billion by investing in highly risky portfolio called CDO7 which was backed by sub prime mortgages.
However, they were showing flawless strong balance sheet including its liquidity to the investors(Yeoh, 2010). 7. Other global megatrends responsible for crisis: There are many other reasons for 2008 global financial crisis, not only US but many other countries also experienced major banking and financial sector weaknesses. Other mega trends that forge global financial crisis are: • Post war trade liberalization which permitted trading business on convenient prices from Asia’s low-priced labour through their economic policies, which were export oriented to keep inflation at bay. Japan’s loose monetary policy for its asset bubble deflation. • Enhancement of quantitative technique in finance which involves complex derivatives, which is helpful but led to the use into a misguided application. For example, Enron debacle in 2002 troughs the unethical procedure and application of off-balance sheet. The slight variation of these financial and accounting concepts increased greed, which contaminated financial modernism and thus unleashed the current global crisis. •
Deregulation of financial services and capital control(Yeoh, 2010) All these developments produced essence of economic crisis, namely, extreme greed, intricacy, leverage and liquidity(Summers, 2000). An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds. 7 GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 9 8. Overall Analysis of US Policies and irregularities: USA is one of the largest consumers of exported product by other nations and also the source of the latest innovations and technology.
As of late 2008, an economic recession took the whole industrialized nations into crisis with the different level of indicators such as: • Extensive range of unemployment • Less export trading volume across many nations those rely on exports. • Volatility of various financial systems • The unstable Financial markets with varying and low stock prices(Yeoh, 2010). All these indicators led to the number of discussions and debates regarding this issue (Melda, 2010).
This report shall focus on main discussion of culture of greed and argue about the unethical corporate governance and regulatory practices in the financial market in US, which were the basic reason for the financial crisis. The discussion follows the major insufficiencies of USA, which were the main cause of GFC: • Failure to regulate financial derivative in the market • Unsustainable economic boom • Excess production of goods • Poor monetary policy • Cashing in on falling share price(Melda, 2010) 8. 1. Failure to regulate financial derivatives: Many economists said that lacking in regulation of financial derivative can ead to the financial crisis. In USA, the crisis mainly triggered by the collapse of financial GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 10 derivative known as the mortgaged Assets which includes prime (Borrowers with good credit history) and subprime (Borrowers with weak credit history) (Yeoh, 2010). Subprime mortgage crisis has put the USA economy into the worst recession. Subprime borrowers are those who have poor credit history but lenders could have seen the other opportunity o make large earning by charging higher interest rate to provide more return for more risk.
Federal Reserve chairman never opposed these derivatives, in other words, intentions of greed came into this scenario (Buser et al. , 1981). 8. 2. Unsustainable economic booms: US Federal Reserve chairman brought down interest rate level up to only one percent for reviving the US economy after Dot-come bubble burst8. This led to the sharp introduction of credit based money into the financial market of the country; these were resulted in unsustainable superficial economic boom. Investors were making money on investments that had no back up.
They knew this fact but greed stuck in the way of ethical investment wisdom of the investors and then whole world eventually paid for their action(Soderbaum, 2009, Melda, 2010). 8. 3. Poor monetary policy: US had Neo-liberal policies for protecting the shareholder’s equity. However, legislators carried out some of the new policies such as Community reinvestment act and expansionary monetary policies to improve their stand in public eye and give investors immediate satisfaction but ignore to accommodate future challenges(Kindleberger et al. , 2005). Thus politicians took the greed affected 8
The dot-com bubble was a stock market bubble which popped to near-devastating effect in 2001. It was powered by the rise of Internet sites and the tech industry in general, and many of these companies went under or learned some valuable lessons when the bubble finally burst. GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 11 decision and pursue those policies that were beneficial in short term but unfavorable in the long term. 8. 4. Excess production of goods: Many multinational companies in US transferred their production to India or China for minimizing their cost of production and increase revenue.
This led to the overproduction which caused deflation of price for goods, but the government hadn’t stepped into set a cap on excessive outsourcing. So greed of power deviated from their decision from long term financial issues, and they ignored out the concern next to globalization(Pettifor, 2008). 8. 5. Cashing in on falling share price: Stock brokers manipulated with share prices and ignored important rules of economics. Their main aim was to bluff people and get the highest return from their respective areas. This was one of the reasons that world went into the global crisis(Hale, 2009). 9.
Conclusion The financial catastrophe has been evaluated through various means of a way. However, each way has shown how greed and unethical regulatory practices were the key driving force in making most of the decision. Politician, investors and traders were equally responsible for this crisis because hunger of politicians for power led them to the failure of the economic policies which could be helpful to avoid this economic crisis. Additionally, greed of making quick money drove investors and stoke brokers to invest in securities, which were not real and created an unsustainable economic boom that later, caused a major economic crisis.
GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 12 Despite the strong governing rules by the Federal government in US, they failed to regulate some volatile financial instruments as they were looking for some quick results that can satisfy their greed for success. To recapitulate this, if all higher authorities in US had played their role in a righteous manner, this situation would have been better. 10. REFERENCE 1. BUSER, S. A. , CHEN, A. H. & KANE, E. J. (1981) Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital The Journal of Finance, 36, 51-60. 2. COFFEE, C.
J. (2009) What went wrong? An inquiry into the cause of the 2008 financial crisis. Journal of Corporate Law Studies, 9,1, 1-22. 3. DONATO, I. I. (2009) The United state:Crisis Leadership in times of transition. IN HART, P. & TINDALL, K. (Eds. ) Framing the global economic downturn :Crisis rhetoric and the politics of recessions. Canberra,Australia, ANU E Press. 4. GROUP, G. L. (2009) The global crisis claims Northern Rock building Society,among others,Viewed on 3 April 2010, 5. HALE, D. (2009) There is only one alternative to the dollar. Financial Times,P. no. 16. London,UK. 6. KINDLEBERGER, C. P. ALIBER, R. & SOLOW, R. (2005) Manias, Panics and Crashes: A History of Financial Crisis,5th ed. , John Wiley & Sons,INC,Newyork. GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 13 7. KREGEL, J. (2008) Changes in the US financial system and the sub-prime crisis, working paper, no 530. The Levy Economic Institute of Bard College. 8. LIN, J. Y. (2009) Policy Response to the Global Economic Crisis. Development Outreach:Putting knowledge to work Washington,USA, World bank publisher. 9. MELDA (2010) Economic crisis a cause of human Greed. Artical alley, Viewed online on 2 April 2010 ; ttp://www. articlealley. com/article_1451059_50. html; 10. NEAL, C. (2009) Growing out of crisis. Develpoment Outreach-Putting knowledge to work for development, 11,3. USA, World Bank Publication. 11. OBAMA, B. (2009b) The state of the nation:address to the joint session of congress,Viewed online on 4 April 2010 12. PETTIFOR, A. (2008) America’s financial meltdown:Lessons and prospects, Viewed online 3 April 2010 13. PHILLIPS, K. (2008) Bad Money: Reckless Finance, Financed Politics, and the Global Crisis of American Capitalism, Newyork times,Newyork. 14. SODERBAUM, P. 2009) A financial crisis on top of the ecological crisis:Ending the monopoly of neoclassical economics. Real-world economics review,49, p. no. 8-19, Viewd online on 5 April 2010 15. SUMMERS, L. H. (2000) INternational finacial crises:Causes, Preventation, and cures. The American Economic Review, 90, 1-16. for development. GSBS6484-Corporate Governance and Social Responsibility 3098673 Page | 14 16. YEOH, P. (2010) Cause of the global financial crisis:Learning from the competing insights. International Journal of Disclosure and Governance, 7, 42-69. GSBS6484-Corporate Governance and Social Responsibility 3098673