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BLOG 3: Where do we go from here?

 

Possible Answer: More regulation of the banking industry and investment industry and more financial oversight (SOX) in businesses.

 

What Measures Have Been Taken Since the Subprime Loan Financial Crisis to Assure This Will Not Happen Again?

 

            One measure that has been taken since the subprime loan financial crisis is the Basel 3 agreements to avoid future financial crises. These are regulations that permit banks to take risks but increase the capital requirements. Basel 3 seeks to limit the ability of banks to leverage capital. The idea is that larger capital provides a larger cash cushion for future losses (Watkins, 2011, p.370). It is doubtful that these requirements alone would be enough to avoid further losses though. Basel 3 may not be enough regulation but regulations like the upcoming FINRA regulations could be too much regulation. FINRA is the Financial Industry Regulatory Authority. In December 2013, FINRA proposed an electronic system that could regularly look into the brokerage accounts of investment firms and see customers’ investment portfolios. The electronic system is called “Cards” and the idea is that it would give FINRA the ability to find out more quickly which firms are placing investors at higher risk. FINRA is possibly an invasion of investor’s privacy. Also it causes too big of a security risk to have a record of each person’s investments across multiple stocks and assets all in one data file and stored in one place. Cards could possibly go to the Securities and Exchange Commission for final approval by next year (Zweig, 2014).

            Another measure needed is to increase Sarbanes-Oxley Act (SOX) regulations in businesses. SOX is aimed at curtailing corporate fraud and increasing oversight of corporate boards of directors. SOX requires companies to have a written Code of Ethics which has to be approved by the SEC.   These measures are good but too much government regulation can be bad.     So where do we go from here? Where we go from here has to be somewhere in-between Bush and Clinton’s laissez-fair policies and the overflowing of government programs we currently have under the Obama administration. Somehow we have to find common ground and that common ground needs to be in the middle. Thiel (2012) says we must have a stronger focus on ethical leadership in the future. “Corporate finance misconduct amidst the recent world financial crisis, such as the predatory subprime lending practices of Ameriquest, Goldman Sachs and IndyMacBank have left few wondering whether ethics leadership should be of greater focus moving forward (Muolo and Padilla, 2010; Palleta & Enrich, 2008).”

References:
Muolo, P., & Padilla, M. (2010). Chain of blame: How Wall Street caused the mortgage and credit crisis. Hoboken, NJ: Wiley.

Paletta, D., & Enrich D. (2008, July 12). Crisis deepens and big bank fails.The Wall Street Journal. Retrieved November 7, 2011 from http://online.wsj.com/article/SB121581435073947103.html

Thiel, C., Bagdasarov, Z., Harkrider, L., Johnson, J., & Mumford, M. (2012). Leader ethical decision-making in organizations: Strategies for sensemaking. Journal Of Business Ethics, 107(1), 49-64. doi:10.1007/s10551-012-1299-1

Watkins, J. P. (2011). Banking ethics and the goldman Rule. Journal Of Economic Issues (M.E.Sharpe Inc.), 45(2), 363-372. doi:10.2753/JEI0021-3624450213

Zweig, J. (2014). Get ready for regulators to peer into your portfolio. The Wall Street Journal. May 3-4, 2014.

BLOG 2

BLOG 2: Is the Great Recession over now? Will profit motives overpower social responsibility again anytime in the near future? If so, what do you think is going to be the next bubble to burst?

 

Possible Answer: We may be coming out of the Great Recession but it could be short-lived because it may just be a matter of time before another economic bubble burst such as a Student Loan Crisis.

 

Evaluating Subprime Loans with the Notion of Social Responsibility. Comparing and Contrasting the Resulting Consequences for These Actions

 

            The Global financial crisis was basically the culmination of multiple negative externalities all coming together at the same time creating a “perfect storm” of financial disaster. These negative externalities were a combination of the desperation of households, the appreciation of housing prices, and declining interest rates (Watkins, 2011, p.366). With the notion of social responsibility, many of the leaders in the banks, in the government and on Wall Street were following the Goldman Rule of pursuing profitable opportunities regardless of the effect it had on others (Watkins, 2011, p.363). Interestingly, this is the opposite of the Golden rule. It was an era of laissez-faire government. Laissez-faire means to let the people do as they think best; free from government intervention. Laissez-faire policies allow the pursuit of profits without restraint. Subprime mortgages were a way to pursue profits. It was a profit-making opportunity too hard to resist. The result was an increase in the opportunity cost for ethical behavior. Acting ethically, would result in a foregone opportunity to make more money. Ethical behavior to avoid hurting others would result in lower profits. The Goldman Rule suggests that lenders would be less likely to be ethical where the opportunity cost of such behavior is high. Banks provided subprime loans without regard to the effect on debtors. They did so assuming a continual rise in housing prices. The collapse in price precipitated the collapse in banking profits, prompting a call for “bailing out” the banks. Government bailouts rewarded banks for “bad” behavior (Watkins, 2011, p.363)

During medieval times, banking was considered unethical. Charging interest was seen as taking advantage of others. “In brief, interest placed the money tender above the social interest (Tawney, 1926). Today, Banking is a capitalistic activity. Bankers are in the banking business to make money. They make money from interest and fees. In a purely capitalistic society, there is little concern for the welfare of society, only concern for one’s self. “I work for nothing but my own profit which I make selling a product they need to men who are willing and able to buy it (Rand, 1957, p.451). In a country where we have property rights, there is incentive to work hard and build up a store of property. Milton Friedman said the only issue is how an individual allocates his property (Friedman, 1962). Friedman believed in free markets but the dominance of the market fosters a pecuniary mindset (Watkins, 2011, p.365). R.H. Tawney referred to “Acquisitive Societies” whose purpose is to promote the acquisition of wealth (Tawney, 1920, p.29). An acquisitive society makes each man the center of his own universe (Tawney, 1920, p.30). Prior to the Subprime Mortgage Crisis, one could argue that America was becoming an acquisitive society. It was a society dominated by self-interest. Since the collapse, Americans have become less interested in acquiring possessions than they were before the crisis. Also they have become more concerned for the well-being of others and for the community and world around them. As Americans, we have developed a greater sense of social responsibility. I believe the Great Recession is over but will profit motives overpower social responsibility again anytime in the near future? Some think the next bubble to burst with be the student loan bubble. Perhaps one could say the federal government is doing the same thing with student loans as the bankers did with housing loans because they are providing loans to people who can never pay the money back unless they get good jobs when they leave college. As we know, good jobs are hard to get these days even with a college degree. Is the current leadership in the government repeating the same mistakes of the banking industry? New legislation may be coming as early as the fall of 2015 that would increase the accountability of universities for the employability of its graduates. President Obama is trying to impose a new rating system for universities where prospective students will be able to tell if they are getting a good value for their money. Studies will be conducted to follow recent graduates to see if they were able to land a good job or not with the skills they learned from the degree they obtained in college. Hopefully, the increased accountability and oversight will be enough to prevent the burst of another economic bubble.

 

References:

Friedman, M. (1962). Capitalism and Freedom. Chicago: University of Chicago Press.

Rand, A. (1957). Atlas Shrugged. New York: Random House.

Tawney, R. H. (1920).The Acquisitive Society . New York: Harcourt, Brace and World.

Tawney, R.H. (1926). Religion and the Rise of Capitalism. Gloucester, MA: Peter Smith.

Watkins, J. P. (2011). Banking ethics and the goldman Rule. Journal Of Economic Issues (M.E.Sharpe Inc.), 45(2), 363-372. doi:10.2753/JEI0021-3624450213

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BLOG 1: What Caused the Great Recession in the United States?

 

Possible Answer: Housing Bubble Burst causing Subprime Mortgage Crisis

 

Summary of the Concept of Subprime Loans and the Risks They Pose to the Lender and Borrower

 

During the years leading up to the Global Financial Crisis of 2008, housing prices were continually increasing. At the same time, interest rates on mortgage loans remained low. In response, presidents like Bush and Clinton wanted to give as many Americans as possible the chance to own a new home and achieve the American dream. Hence, financial institutions started offering more flexible ways of obtaining a home loan. Some of these loans were called Subprime Mortgage Loans because the borrowers were at higher risk of defaulting than borrowers who received Prime Loans. Prime loans have the lowest interest rates and best terms while subprime loans usually have higher interest rates and worse terms. Typically, a subprime loan borrower had a worse credit history and insufficient income making it harder for them to pay back the loan. Also these borrowers were only required to put down a small down-payment and sometimes no down-payment at all. Therefore, subprime borrowers posed a higher credit risk to lenders. One type of Subprime Mortgage loan was called an ARM, Adjustable Rate Mortgage. These Subprime Mortgages offered low initial interest rates called teaser rates but they were adjustable rate mortgages rather than fixed rate mortgages. The adjustable interest rates were subject to increases causing the borrower to have larger monthly payments. If the borrowers cannot make the larger payments they would have to refinance at a lower interest rate or pay-off the loan (Watkins, 2011, p. 366). The borrower was betting the interest rates would not go up. The lender was betting that even if the rates did go up and the borrower could not pay back the loan, it would not create a bank loss because since housing pricing would keep appreciating, the lender could always repossess the house and sell it for more than its loan value. The problem with this logic is that no one thought of what to do if housing prices started dropping. However, this is exactly what happened. Interest rates started rising. The interest rate on the adjustable rate mortgages started increasing. Some borrowers saw their loan payment amount double. When this happened, many of them could not repay their loans and their houses went into foreclosure. With so many houses now on the market, the increase in the supply of homes available for sale caused the prices of houses to fall. Many of these loans were securitized and bundled together with other stocks, then sold on the stock market to investors. These were called mortgage-backed securities. Some of these investors, especially foreign investors had invested in U.S. stocks relying on the triple-A credit ratings from credit rating agencies like Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.   Once the housing bubble burst and the value of these stocks plummeted, investors at home and abroad lost a great deal of money. The economic effects were so severe that it became known as the Global Financial Crisis of 2007-2008. This was followed by the Great Recession of 2008-2012.

 

Critique of the Role of Leadership Decision-Making in the Subprime Loan Financial Crisis

 

           Who was to blame for the Subprime Loan Financials Crisis? Many possible suspects exist. One could say it was the lenders because it was unethical for them to make housing loans to people who had little ability to pay the money back. Also, in many cases, the banks were too lenient in their loan approval process. In some instances, as long as the borrower had a decent credit rating, the loans was approved based upon a statement of income and the borrower did not have to provide proof of income. Companies like AIG also sold mortgage protection insurance to the banks so that if the borrower defaulted, the insurance would cover the loan balance so the lenders were not really worried about whether or not the borrower was going to be able to repay.   Also the bankers knew they could eliminate all risks by getting the loans off their books. This could be done by selling the loans to securitizers. Securitizers were investment banks like Lehman Brothers, Bear Stearns and Merrill Lynch and GSE’s (Government Sponsored Enterprises) like Fannie Mae and Freddie Mac. The securitizers combined these loans with other securities and they were sold on the stock market and regulated by the Securities and Exchange Commission (SEC).

The borrowers themselves could be blamed because they should have been more prudent in handling their financial affairs. After all, no one forced these borrowers to take out the loans (Gilbert, 2011, p.99). Also some of the borrowers had been dishonest when answering income questions especially if they really needed the loan. Sometimes, the borrowers were just refinancing their homes to get a second mortgage. In other words, they were just taking the equity out of their house. Due to a period of stagnant wages and rising prices just prior to the burst of the housing bubble, many people strained themselves financially in order to keep up their same lifestyle. Credit was easy to get so they had multiple credit cards and were already burdened with overwhelming debt before they refinanced their homes. They refinanced their homes in order to obtain more money but this just put them deeper in debt while the real problem of stagnant wages and increasing inflation still existed.

 

References:
Gilbert, J. (2011). Moral duties in business and their societal impacts: The case of the subprime lending mess. Business & Society Review (00453609), 116(1), 87-107. doi:10.1111/j.1467-
8594.2011.00378.x

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Hello, my name is Darlene Casstevens. I am a Masters in Economics graduate from North Carolina State University. I teach Business and Economics part-time at Salem College and Surry Community College.

INTRODUCTION

Hello, my name is Darlene Casstevens. I am a Masters in Economics graduate from North Carolina State University. I teach Business and Economics part-time at Salem College and Surry Community College.