The financial crisis of 2008 affected different sectors of the global economy. Most of the initiatives undertaken by the Treasury Department and the Federal Reserve did not deliver meaningful outcomes. In 2007, banks began to panic since they were forced to absorb most of the losses recorded in different countries or economies. Within the next twelve months, the levels of dishonesty and mistrust increased significantly, thereby increasing interbank borrowing expenses.
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Using the documentary “Inside Job”, the paper presented below asserts that the malpractices of different banking experts, the ethical dilemma revolving around ratings agencies’ actions, and the Gramm-Leach-Bliley and the Glass-Steagall Acts influenced the nature of the 2008 banking crisis and its aftermath.
Secularization Food Chain
The documentary “Inside Job” uses the phrase “securitization food chain” to describe how different banks purchased and packaged illiquid debts before securitizing and selling them to unsuspecting investors. The idea of securitization entails the application of financial engineering to transform illiquid assets into securities. According to the film, the first step is the application of mortgages by property owners. Banks then decide to originate the loans.
They can sell mortgage notes if borrowers fail to repay. The second stage of the chain occurs when mortgages are combined or bundled to form something called a mortgage pool (Ferguson, 2010). This can be held as mortgage-backed securities (MBSs). There are specific aggregators who can issue MBSs. The final outcome is that the process creates a new security. The created MBS can also be broken down into a number of tranches (also known as parts).
The nature of the emerging large market provided liquidity to the tranches, thereby making them less illiquid. Finally, pension funds decide to invest in MBSs that have high-credit ratings. Bayar (2014) indicates that hedge funds will focus on increased returns by purchasing MBSs with reduced credit ratings (Bayar, 2014). This means that the investors’ return on investment (RoI) is usually obtained from the proportionate mortgage payments.
Several individuals were engaged in different activities and initiatives throughout the 2008 financial crisis. One of these key figures is Henry Paulson. Paulson was Goldman Sachs’ Chief Executive Officer (CEO) and chairman from the year 1998. According to the documentary, he managed to write a report that proposed a number of initiatives to overhaul America’s financial regulatory system. He believed that globalization had resulted in new changes and innovations in financial engineering. This development could have been considered to design newer or superior models for managing finances and preventing future market disruptions.
This means that Paulson supported a new financial regulatory system that would support investors and consumers. Paulson could have engaged in unethical practices as the CEO of Goldman Sachs (Ferguson, 2010). This was the case since the corporation could have benefited from the implemented securitization plan. Although he had no direct financial expectations or interests, some analysts believe that Paulson’s decision to sell his shares at the company was something questionable in accordance with the existing ethics law.
The second person whose role influenced the events leading to the 2008 crisis was Alan Greenspan. From the year 1987, the Senate confirmed Greenspan to work as the chairman of the Federal Reserve’s Board of Governors. In 2000, the chairman chose to increase interest rates severally. Ferguson (2010) believes that such actions played a significant role in causing the financial crisis of 2008.
This was the case because Greenspan failed to impose appropriate margin requirements for stock markets. The decision to deal with emerging challenges using several tactics catalyzed the 2008 banking crisis. In 2003, commodity prices began to rise significantly due to Greenspan’s monetary policies. From this analysis, it is evident that Greenspan supported ineffective monetary policies and actions that led to numerous economic challenges. This means that his actions were ethically questionable since he failed to solve problems in advance. Hrunga and Seligman (2015) indicate that Paulson predicted the 2008 economic meltdown because he was aware of the inappropriate initiatives the Federal Reserve took during his leadership.
The selected documentary reveals that the malpractices of ratings agencies played a major role in the 2008 crisis. These organizations usually analyze the risks associated with different debt securities and advise investors accordingly. Some of these securities include municipal bonds, government bonds, corporate bonds, collaterized debt obligations (CDOs), preferred stock, and mortgage-backed securities (MBSs).
The risk surrounding these securities is informed by the debt issuer’s inability (or ability) to make appropriate interest payments. The 2008 economic crisis shows that ratings agencies’ actions could have widespread consequences for markets and investors. Some of them included Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings. During this meltdown, the leading agencies misrepresented the major risks associated with MBSs in the United States (Ferguson, 2010).
The ethical dilemma these agencies face is whether they should focus on the investors’ needs or possible economic crises. Additionally, the absence of proper corporate responsibilities for organizations in the CRA sector makes it impossible for them to have uniform standards of practice. With these gaps in place, such agencies chose to use complex models to predict the possibility of default for bundled mortgages. They indicated that the bundling of mortgages was a top-tier AAA material (safest and highest). However, they downgraded such MBSs after the housing market began to collapse in 2008.
Glass-Steagall Act and the Gramm-Leach-Bliley Act
The U.S.A. Banking Act of 1933 (also called the Glass-Steagall Act) was put in place to separate different forms of investment and commercial banking. Henry Steagall and Carter Glass sponsored this bill. The law was intended to prevent investment banks and securities firms from deposit-taking activities. The Act also prevented banks from distributing securities, sharing employees with investment firms, and investing in securities in an attempt to make profits (Ferguson, 2010). Consequently, this law made it impossible for banks and security firms to partner and pursue their organizational goals.
In 1999, an act of Congress repealed parts of the Glass-Steagall Act, thereby resulting in the Gramm-Leach-Bliley Act (GLBA). The purpose of this new law was to remove existing barriers that prevented securities companies and banks from engaging in combined business activities. The new Act empowered insurance companies, securities firms, commercial banks, and investment banks to consolidate and pursue their objectives (Bayar, 2014).
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Unfortunately, the law did not give regulatory powers to different agencies and authorities in the country. Consequently, the banking crisis of 2008 can be studied as one of the outcomes of these laws. However, I personally believe that the two laws did not result in this economic upheaval. Ferguson (2010) indicates that the policies implemented by the Federal Reserve and the malpractices of different ratings agencies led to this meltdown. Future scholars should, therefore, focus on these issues and propose evidence-based solutions to protect the global economy from a similar catastrophe.
The identified documentary is informative and meaningful because it examines the history and nature of the 2008 banking crisis. The insights gained can guide people to dig deeper in order to understand the nature of the upheaval. I have realized that several players and actors failed to engage in meaningful practices and initiatives before 2008. Securities agencies and government institutions did not offer appropriate recommendations and policies to protect the country from a potential economic crisis (Ferguson, 2010). Personally, I felt sympathetic because a major malpractice by ratings agencies forced investors and companies to make erroneous decisions. Consequently, many citizens were left homeless and incapable of pursuing their economic goals.
Another outstanding argument is that I was not aware of each of the things discussed in the selected documentary. However, I understood that the 2008 financial crisis was associated with ineffective accounting practices embraced by different auditing firms in the United States. This means that such catalysts are linked to the misbehaviors of policymakers, banking experts, and ratings agencies (Hrunga & Seligman, 2015). Policymakers should, therefore, study these connections carefully in order to present evidence-based ideas to protect the world from another financial crisis.
The above discussion has revealed that the “securitization food chain” described in the documentary “Inside Job” catalyzed the financial crisis experienced from the year 2008. The roles and actions of Alan Greenspan and Henry Paulson also dictated the course or development of this upheaval. Although some of the existing laws could have prevented this recession, experts should identify evidence-based ideas and solutions in order to govern the activities undertaken by banking institutions and securities firms in every part of the world.
Bayar, Y. (2014). Recent financial crises and regulations on the credit rating agencies. Research in World Economy, 5(1), 49-58. Web.
Ferguson, C. (Director). (2010). Inside job. Web.
Hrunga, W. B., & Seligman, J. S. (2015). Responses to the financial crisis, treasury debt, and the impact on short-term money markets. International Journal of Central Banking, 11(1), 151-190.