The financial crisis starting in 2007 and continuing to the present has had a broad impact on the United States and global financial markets, as well as the personal lives and well-being of many Americans. There were a variety of factors that led to our current financial situation and ethical issues related to each one. Discussed in this paper are the ethics involved in the deregulation of the financial markets, predatory lending of subprime loans, CEO bonuses, credit rating agencies, and government bailouts.
The current financial crisis may be the worst since the Great Depression according to many economists (Reuters, 2009). Fortunately the effects felt by the average American aren’t nearly as severe as during the 1930’s recession. That being said this recent financial crisis has had disastrous effects on the housing market, investor’s personal finances, and the world economy as a whole. The combination of deregulation of the financial markets, predatory lending by banks, CEO incentives to make risky investment decisions, and irresponsible if not untruthful analysis by credit rating agencies led to the initial collapse of the subprime mortgage market, and in turn set off a chain reaction throughout the rest of the economy.
The first aspect to explore is the government’s deregulation of investment banks. Deregulation of financial institutions is a trend that has survived since the Carter administration. In the last couple decades the U.S. government has repealed restrictions, set in place after the Great Depression, on bank’s financial practices leading to a series of increasingly risky investments. Several administrations contributed to the eventual lack of regulations which allowed the irresponsible ventures of many U.S. banks (Leibold, 1988). The first being the Depository Institutions Deregulation and Monetary Control Act of 1980 that phased out lending restrictions and raised the deposit insurance limit to $100,000 (Federal Deposit Insurance Corporation, 1997). The next law in the series was the Garn-St. Germain Depository Institutions Act which allowed banks to issue adjustable rate loans and had a direct tie to the savings and loan crisis. In 1999 President Clinton signed a law that reduced the separation between investment and commercial banks. Then in 2004 the SEC increased the amount of debt financial institutions could take on which caused a rise in subprime mortgage securities investment.
A report issued March 4th by Essential Information and the Consumer Education Foundation documents billions of dollars spent by financial institutions on lobbying politicians to pass legislation that repealed regulations on their industry. According to the study insurance conglomerates such as AIG and investment banks like Goldman-Sachs made political contributions totaling $1.73 billion and spent another $3.4 billion on lobbyists. The combination of lobbying and campaign contributions to politicians who make financial policy in the U.S. led directly to the passing of laws which eventually caused the current financial collapse. The ethical misconduct by politicians who accepted these legal bribes is obvious. Accepting campaign contributions and thinly veiled bribes is not illegal even though the ramifications of their actions caused the single greatest financial crisis since the 1930s.
Deregulation and government policy, specifically attempts to reach out to home buyers with less than ideal credit scores, led to the next factor in our current economic situation. Predatory lending of subprime mortgages by banks skyrocketed in 2005 and 2006 (Reuters, 2007). Banks such as Countrywide Financial employed a bait and switch method, advertising low interest rates then swapping them for Adjustable Rate Mortgages with high interest rates. Outright mortgage fraud was common also. Companies such as Ameriquest implemented a system where mortgage documents were falsified and then sold to Wall Street banks in order to make fast profits. According to some former employees of institutions like Ameriquest, employees were encouraged to participate in these illegal and unethical practices for the benefit of the company. While falsifying documents and selling bad loan products to customers is obviously unethical many employees felt obligated to either overlook or actively participate in these schemes in order to keep their jobs and promote the company’s bottom line. Some of these workers may have taken a deontological approach to assessing the ethics of their behavior, rationalizing that their duties were to the company and protecting their financial well-being instead of protecting their customers and the stability of the economy.
Another factor which contributed to the economic crisis was the incentives to CEOs of banking institutions. CEOs were given multi-million dollar bonuses to make short-term profits for their companies. With such incentives on the table it is easy to see why CEOs would undertake investing ventures with excessive risk involved at the expense of their own company, the shareholders, and the employees. Many of these CEOs acted selfishly and irresponsibly, looking out for their own well-being and disregarding the effects their potentially dangerous investment practices could have on the financial industry. Any ethical analysis of their actions should have raised red flags and discouraged further risky investment. If the CEOs examined their action through a utilitarian lens they would see that their actions negatively affected all the stakeholders involved besides them. Looking at the situation using a deontological approach these business leaders would have seen that their duty to the company and the financial industry as a whole outweighed their own personal interests. Using the abstract moral principles associated with deontological theory it is obvious to see that the CEOs decision to undertake dangerous investments did not hold with values such as fairness, rights, justice, responsibility, and respect for other people.
The most disturbing factor that contributed to the financial crisis was the inaccurate and misleading assessment of risk by supposedly impartial credit rating agencies. By giving triple A ratings to mortgage securities credit rating agencies encouraged investment in CDO (collateral debt obligations) and MBS (mortgage-backed securities) investment vehicles (Salmon, 2009). These securities consisted of bundled subprime and Alt-A mortgages which carried a high risk factor. Credit rating agencies are paid by the same financial institutions whose products they are rating, creating a conflict of interest. By giving these potentially dangerous investments AAA scores, credit rating agencies falsely reported the risk and by deceiving investors made investment banks billions of dollars and contributed to the eventual market collapse.
These ratings, solicited by the companies who sold the products, were a massive revenue source for the rating agencies. These companies enjoyed record profits and stock prices while setting up the markets for their ultimate collapse. As an email from one employee at the credit rating agency Standard & Poor’s states, “Rating agencies continue to create an even bigger monster- the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.” Communications like this lend credence to suspicions that credit rating agencies knew of the threat these investments posed and chose not to report it.
After the housing bubble burst the full effect of the investment banks actions became clear. Due to the less stringent financial regulation banks had over-borrowed and over-invested in mortgage backed securities and as a result during 2007 and 2008 over 100 mortgage lending companies declared bankruptcy (Altman, 2009). Major institutions such as Lehman Brothers and Merrill Lynch either were bought out, declared bankruptcy, or were taken over by the federal government. In an effort to reduce the effects of this disaster the FDIC took over many struggling and insolvent banks. Many have questioned the economic and ethical consequences of these bailouts which have to date spent over $700 billion to keep companies like AIG and Citigroup afloat. Is it right that the government is using taxpayer dollars to bailout banks whose unscrupulous and greedy investing has put them out of business? Financial institution’s unethical business practices have created a disastrous financial crisis and in turn government officials are directing taxpayer dollars to save them. The policy makers in Washington have a definite conflict of interest with the banks who, previous to the financial meltdown, lobbied to deregulate their industry. Their legal but unethical manipulation of government economic policy is now being returned in the form of government financial aid.
The recent financial crisis is a wake-up call to everyone who considers ethics in business important and necessary. The blatant disregard for the well-being of investors, stockholders, and homeowners as well as the economic stability of our country by large banks and lending institutions should cause concerned American citizens to look more closely at the business practices of these institutions and the policies set by the government to regulate them. Understanding the ethics involved in the deregulation of the financial markets, predatory lending of subprime loans, CEO bonuses, credit rating agencies, and government bailouts are vital to preventing another crisis of this magnitude from happening again.
Altman, R. C. (2009). Altman-The Great Crash. Foreign Affairs .
Federal Deposit Insurance Corporation. (1997). History of the Eighties – Lessons for the Future, Vol. 1.
Leibold, A. (1988). Some hope for the future after a failed national policy for thrifts. Milken Institute.
Reuters. (2009, February 29). 3 Top economists agree 2009 worst financial crisis since great depression.
Reuters. (2007). Spending Boosted by Home Equity Loans.
Salmon, F. (2009, February 23). Recipe for Disaster: The formula that killed Wall Street. Wired Magazine .
By: Luke Jackson
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