Introduction
The recent economic troubles in the United States as well as the global economy have caught the attention of everyone. Not only have they caused millions of ordinary Americans to lose their savings, they have also contributed to the economic gloom of the present times. They are an indication of the troubled state in which the global economy finds itself. This paper looks at the specific role of corporate greed in exacerbating the crisis.
The current crisis
To have a brief introduction for the present crisis, the housing market was inflated to a large extent because of loans made to borrowers who had bad or no credit history. These kinds of borrowers were called sub-prime of below the prime required for a good credit history. Once the loans were made arbitrarily, the homeowners went for further capitalization by refinancing their mortgages and borrowing against the houses. All this went on till the housing market corrected itself and the housing prices started to come down. This meant that the bubble started to burst.
While the housing market bottoming out does not really make the whole economy go bust, it is the aspect of building up value on top of the mortgages through a form known as securitization that we will discuss later. And then the same were collateralized in the form of instruments known as CDS that gave the whole thing the look of a crisis of epic proportions.
Greed
The current crisis has been brought about by a combination of factors that can be defined as “Bad in the systemic sense further applies to letting a financial elite elevate, expand, and entrench itself as a country’s GNP-and profits-dominating sector, as has been done in the United States over the last quarter century. Doing this so hurriedly has wound up institutionalizing runaway public and private debt, gross runaway public and private debt, gross speculative biases, tenfold and twenty fold leveraged gambling, unchecked and barely regulated “product” innovation, and a tendency toward periodic panics and instability” (Kevin Philips, p. 63). Thus, as one event led to another, it was the underlying principle of profit making coupled with an insatiable greed that wanted more instead of being content with the profits that they were earning that led to the bubble being inflated.
As the corporates began to expand their balance sheets and post extraordinary profits, it became apparent that the rates of return that they were getting on their capital could not be sustained over a long period of time. However, despite warnings to the contrary, there were few of the big corporations that actually took notice of the impending crisis. In a world that was driven by the lubricant of money, the promise of more seemed alluring and irresistible
Though it is not the intention of this author to blame corporate greed for everything, nonetheless it has to be borne in mind that capitalism thrives on excess and hence is the perfect vehicle for profit making as well as risk taking. While the entrepreneurial spirit and the ability to take risks have contributed to the success of the global economy, the fact that reliance on excessive profits has spelled doom for the global economy as well.
A term called securitization defined as “What’s securitization? Some will ask. A pompous six-syllable word, to begin with, but also a humongous new business launched by Wall Street in the 1990s. To oversimplify somewhat, sophisticated financial institutions discovered gold in tying together five hundred or five thousand loans, mortgages, or whatever, and then selling fresh securities” (Kevin Philips, p. 8) led to leveraging on a scale never seen before in the economic history of the nation. In layman terms, what this means is that the ever increasing returns that one expects on the underlying asset is then sold off for higher values thus giving rise to a concept called leveraging. The ratio of the “securitized” debts to the value of the underlying assets reached dizzying proportions. And here lies the catch.
Once the sub-prime mortgages on which the overlay of the securities was built up, began to default with the housing market flattening out, the “bottom” of the market literally fell apart. Some have called the current crisis as a “race to the bottom”. What they are implying is that as the “derived” value of the assets comes crashing down with the fall in value of the underlying asset, it is anybody’s guess where the market would flatten out.
Some tough questions
As is the norm when any crisis erupts in any sector, so is the case with the financial sector. Some questions that are being asked now are: “We advocates of relatively unfettered capitalism have strong exculpatory arguments: Who inflated the housing bubble with 1% money in a strong economy? (The Greenspan Fed.) Who encouraged all sorts of low-income, high-risk borrowers to acquire mortgages and homes they were doomed to lose? (Government agencies of all stripes.) Who created the stock-option mania in big investment companies by capping tax deductions for executive salaries? (Congress, in the early 1990s.) Who prolonged the current crisis with continuing destructive ambiguity, still unresolved, about which institutions would be bailed out and which wouldn’t be? (Today’s regulators and policy-makers.)” (Foster, 2008).
The answers to all these questions depend on the same pivot: lack of regulation and an “irrational exuberance” that though identified was not acted upon. The results are there for all to see. As the panic in the markets refuses to subside and the markets in free fall, the questions may very well lead to recriminations. And in this context, the election of Barack Obama as the 44th president of the United States means that there might be more regulatory oversight and a throwback to the old days where de-regulation was not the buzzword as it is being made out now.
Opportunity
While this current crisis may seem to be going out of hand, it is also a good time to think on how to capitalize from it. There can be an expansion of health care and social security benefits to the people who are affected by the crisis. Further, credit availability and Obama’s plan of financing the mortgage owners who lost their homes could be a viable alternative.
Conclusion
While we have seen the technicalities of the origins of the current crisis and their implications for the economy, what is unmistakable is that greed was the underlying emotion driving the bubble in asset prices as well as the value built up on the same. Thus, there were no mechanisms to stop unfettered greed and that “the crisis is a result of “crony capitalism and an economic philosophy that sees any regulation at all as unwise and unnecessary.” (William Watson, 2008). Thus, another element that got added was hubris and lack of proper regulation.
The potentially lethal cocktail of greed, hubris and an infallible faith in the principles of markets and the desire to be free of regulation added to the crisis reaching gigantic proportions. In conclusion, it appears increasingly unlikely that the crisis is going to abate anytime soon. Thus, the focus now should be on next steps and how to prevent another such crisis from engulfing the national economy.
References
- Philips, Kevin. Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. New York: Penguin, 2008.
- Foster, Peter. “No Fallen temple”. FP Comment. 2008.
- Watson, William. “Regulating Hubris”. Financial Post. Web.