Balancing Company Interests vs. the Public Interest
Contract Law and Professional Ethics
The financial crisis of 2007 was a failure of trust between the banks before the 2008 crisis mishap. All of this was caused by the unregulated use of byproducts of the subprime mortgage crisis. Despite all the steps taken by the US Treasury and the Federal Reserve, this still led to a great recession. Doing this time, the selling of existing homes peaked at a high of about $5 million. Doing this time frame homes were selling for about $230,000.00. In Aug of 2007, the Federal Reserve raised the interest rate to 5.25 which new home peaked to about $250,000.00. Each month brought more bad news, but no one wanted to agree on how bad it really was. Even though the bear market and the stock market were stable it was not the same for the housing market (Amadeo, 2007). By Dec 2007, the Fed lowed the rates to 4.25, banks stopped lending money, for they were afraid of getting caught with many bad subprime lending mortgages. The Fed believed that by lowering the rates, this would be enough to restore confidence in the market.
As mortgage rates drop, homeowners took advantage of it, and took their equity out of their homes and use it to help pay off other bills. Without equity in the home, the homeowners have little incentive to pay off their homes, that they could no longer sell for a profit. Economists didn’t think that the price would drop so low. They also though homeowner would take their homes off the market before selling at a loss, they thought they would refinance. Most people thought the homeowner would refinance and this would reduce foreclosures. But they didn’t consider, banks wouldn’t refinance an upside-down mortgage.
March of 2007, the mortgage slump spread to the financial services industry. Many hedge funds investor had put a large unknown amount into the mortgage-backed securities, which were not regulated by the Securities and Exchange Commission (SEC). So, no one knew just how much of the funds were mortgage-backed and what would the effect be on the housing market. Since hedge funds use complex derivatives, the crash could be amplified. Derivatives can permit hedge fund investors, to appropriate money to make all kinds of other investments. This way they earn a higher investment in a good market but once it turns the other way, the derivatives increase their loss. As the derivatives plummet, and the stock market drops, it adds to the subprime lender’s problems.
The Treasury Secretary Hank Paulson tasked three banks to set up a 75 billion superfund account, these banks were JPMorgan Chase, Citigroup and Bank of America (BOA). This superfund account would be managed by Blackrock investment group for buying obsolete subprime mortgages (Amadeo, 2011). This was supposed to help ward off additional economic drops, this was to give banks time to figure out how to handle the derivatives. The federal government would guarantee the banks as they take on more of the subprime debts.
This crisis is known to anyone involved in the corporate world as the crucial point where the country plunged into a long and very deep financial recession with no end in sight. What followed was massive effects that were taken seriously and impacted a lengthy unemployment surge, and major declines in the gross domestic product. Unemployment which had always been overlooked resulted in a decline of jobs which struct early 2008 and lasted through the next year or two. Unemployment rates trickled to 7.8% or higher (TFCIC, 2011), which was something not witnessed for decades.
The financial crisis in America was due to many factors between the banks and consumers. This was started with the US subprime crisis of mortgages. Some of the reasons for the crisis includes an imbalance in international trade, household debt and the bubble of the real estate. The US government housing policies and less regulation for non- depository financial institutions are another reason. The government changed their fiscal policy, central bank monetary policies etc. Bailout packages were given to the banks which are in trouble. The bubble in the real sector was caused due to the increase in savings. The sudden collapse of it causes because they invested their money in risky securities (TFCIC, 2011).
Many individuals have identified the source of the crisis to be poor risk controls, high leverage, and a blind eye from corporate fools avoiding the housing market when trying to find ways to turn a profit. In all reality, it was the unethical behavior of these individuals that led to the crisis, almost as if they were drunk and did not care what the outcome would be. On the flipside, it is easy to point out those reasons as the cause for the financial crisis on the housing market, but the picture was much broader. It was the collapse of ethical behavior that fell first before the housing market. Once the financial industry realized there was no turning back, they were now free to behave in whatever manner they wanted to. From there, top executives disregarded short-term interest and pretended that the longer-term impact would not hurt their customers. It was at this point that they simply showed no remorse for the damage made on the American economy, their firms’ employees, or the many Americans who simply were living the ‘American Dream.’ In order to fully understand the beginning, middle, end and the future of the economy and housing market, an in-depth look must be conducted not so much towards financial entities, but to the unethical behavior displayed throughout the crisis. We can analyze the financial crises such as the personal ethics of the financial crisis, organizational ethics, social ethics, moving forward post-crisis, and lessons learned from the financial and housing crisis.
Throughout the years since the financial crisis and the downfall of the housing market, it has been repeatedly said that greed was the root cause of the monumental event. A selfish and excessive desire for money that was needed was one of few traits that executives were displaying. When someone wants to increase the input of cash flow within a corporation or major player in the financial market, they’ll do whatever it takes to achieve that. It is then when decisions are flawed, and tunnel vision becomes active. Other unethical behaviors such as the ability to restrain the desire for success, cowardice, unprofessional conduct, and lack of strength were clearly visible. For example, managers who can plainly see what was going on refused to stand up and say something or evaded any much-needed decision making that could possibly risk their careers or the life of the company they are working for. All of this led to various situations of injustice such as: “withholding of important information, unlawful advertising, unethical operations to generate higher commissions, manipulation of corporate stock options” (Arbogast, 2013).
When considering various virtues of the common banker during the crisis, one virtue sticks out like a sore thumb, prudence. Prudence became difficult to conduct during this time due to the environment surrounding the individual, leaning more towards high-growth, low-interest rates, and many opportunities to turn a profit. All of these elements then contribute to the most perfect environment surrounded by poor management and poor decision-making. This was not just the thinking of one banker, but practically every banker as they tried to take advantage of what was occurring around them. Realistically in the mindset of a banker when there is so little to lose and so much to gain, selfishness and a potential ‘cash-out’ before the storm then becomes a goal that needs to be achieved. Being careless with that kind of attitude is what initially caused many financial institutes to suddenly go from looking highly successful to paddling for dear life hoping that the crisis would go away overnight.
Greed is a natural virtue that every human always feels. So, if greed is always present, then why did it take so long for it to present itself at the initial phase of the crisis and not previously in the United States or other countries? There could be an argument made that all the pieces of the puzzle aligned which made it easier for individuals to seize the opportunity, therefore creating an environment filled with bankers with greed as their motive to act unethically. Between the social, legal and institutional changes that were occurring, perhaps created a shift in society’s values, and resulted in the mindset of, greed is good. It could also be that during this time, prior to the crisis social issues such as a relaxed legal system, constant economy values, and a stable housing market all but ensured that these individuals, executives, higher management and financial figures knew they could act unethically only because that was what was expected of them during those circumstances (Schoen, 2016).
It is easy to point the finger at organizations and corporations unethically during the financial crisis. There are two reasons why these directors, senior managers, and analysts within these organizations failed not only the economy but the nation, and there are bad governance and a serious lack of professional competence. Bad governance manifested itself in risk analysis, which according to management, means that key management representing these organizations began to start making major risks, knowing that they are below sea level during a time where a loss was unacceptable. Prior to the first phase of the crisis, these executives entrusted young and inexperienced professionals to handle financials, top-level decisions, and risk assessments.
Financial institutions were financing to borrowers for a housing loan. They were financing the loan by lowering their credit standards. Through that, they were able to meet the demand of borrowers. The mortgage value of the loan was lowering the security of mortgage. They were all sharing high risk due to this. The impact of this led to increases in the value of the property. The financing system of these loans is such that the initial rate of interest is low but the installment payment after that is high. When the borrowers were not able to pay off the loan the number of bad debts increased. This was a very huge number and a sudden collapse of this loan led to failure in the whole financial system. The excessive use of debt in investing real sector can be said as the risk in the failure of the financial system. This all can be termed as high-risk lending (Amadeo, 2007).
The post-crisis let’s move forward, no one could have predicted excesses such as too much leverage, poor risk controls at the highest level, and improper business practices prior to the crisis itself. The same goes for any predictions made about how fast the economy and the housing market could recover after the dust settled. It is 2018 and the housing market is barely starting to look subtle, and that’s optimism at its finest. During the crisis, society had thought that these individuals and executives, somehow on one early morning decided to take a stroll down Wall Street and somehow all inhaled some sort of disease that blocked any common sense or proper decision making. What they also attempted to figure out was how was it that the whole financial and housing market collapsed all at once, nearly every big-name firm such as Lehman Brothers Holdings was destroyed or badly crippled, and how the economy was suddenly, unrecognizable. Regardless of the image that was portrayed towards those individuals, the nation needed to recover. The housing market needed to prosper in ways that it prospered prior to the crisis. Families who had lost their homes and jobs needed to figure out how to regain stability in their lives. Young financial professionals needed to find a way to recover that positive image they once had and seek employment again. The ethical behavior across the whole financial industry was destructive and it was no secret.
In response to the crisis, the Dodd-Frank Wall Street Reform (Dodd-Frank Act) was created in hopes that it could be a long-term solution and an avenue to correct the unethical conduct of major financial institutions who were conducting unsafe business practices. This act mandated that all taxpayer money never be used to ‘bail out’ financial institutions and minimizing the powers of the Federal Reserve to provide life into financial institutions that suffered from the crisis (Amadeo, 2011). Additionally, the Dodd-Frank Act directs all regulatory agencies to issue a massive series of regulations, creates safe bureaucracies, and imposes costs to financial institutions in order to comply with all financial requirements (Amadeo, 2011). This was simply the answer to the financial crisis that should have been passed prior to all of the lying, corruption and selfish acts that created the financial and housing market crisis.
Small banks like American Express, Ally, and Barclay Bank, no longer can be label as too big to fail. They do not have to submit the mortgage reports or even follow the fair lending rules. The top 10 largest banks do have to follow and comply with the Dodd-Frank fair lending rules. Trump claims that the Dodd-Franks act hurts small businesses, but the act does not, for it only targets the large banks. Most small businesses normally borrow from small banks, not the big ones. The bigger banks have much higher interest rates than the smaller banks, since the financial crisis.
Some of the thing that we needed to do to try and fix the problems, this was done by people who will not try to cover up the problems, own their mistakes, who plays by the rules and mainly they will try to fix the problem with well throughout the solution. Here are several ethical ways which a business/bank can attempt to resolve the mortgage issues:
They needed to adapt and focus on the customers’ needs and their welfare. Placing the client’s interest above their compensation interest of the executives. Hopefully, this will help lessen the blow of their unethical decisions.
They need to look deeply into, monitoring, eliminate the conflicts of interest and money-making scheme of the banks.
The public needs to demand the banks follow ethical behavior across the board with the executives and employees. This need to start at the top and have them to take responsibility for the action of their organization and its employees. Someone needs to be held responsible for these matters when they happen, and not let them go unattended. Manager and the executives have to play a major role in fixing this problem before it gets out of hand and keep happening over and over again and no one cares to fix it.
There are some things that we as the consumer should do to prepare ourselves for these changes in the economy. Some safeguards should be in place when bad executives and unethical financial banks take advantage of use and they never learn from their first mishap. Some lesson that we might need to learn for ourselves are:
Your home is not always a safe investment: Most homeowner believes their home value would only go up. This can lead the homeowners to borrow too much from a bank and just make thing worst.
The homeowner should have emergency funds: This should be something we all should have, whether in a crisis or not. We should have at least three to six months of expenses set aside for a rainy day. With these funds, you should be able to maintain your living condition for that time frame.
Buy what you can afford, not what you qualify for: Just because they tell you, you qualify for a $500,000.00 home does not mean that you need to buy it, or that you can afford the payments. The bank does not know what you want or need, nor do they know the other expenses that you may want to purchase soon.
Amadeo, K. (2007, August 15). Here’s How They Missed the Early Clues of the Financial Crisis. Retrieved from https://www.thebalance.com/2007-financial-crisis-overview-3306138TFCIC. (2011, January). The Financial Crisis Inquiry Report. Retrieved from https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdfAmadeo, K. (2011, April 26). How Trump Weakened Dodd-Frank and Increased Your Risk. Retrieved from https://www.thebalance.com/dodd-frank-wall-street-reform-act-3305688Schoen, E. (2016, February). The 2007?2009 Financial Crisis: An Erosion of Ethics: A Case Study. Retrieved from https://link.springer.com/article/10.1007/s10551-016-3052-7
Arbogast, S. V. (2013). Resisting corporate corruption: Cases in practical ethics from Enron through the financial crisis. Beverly, MA: Scrivener Publishing. Retrieved from https://onlinelibrary.wiley.com/doi/book/10.1002/9781118659069