Ethical Critique of the 2008 Financial Crisis

In 2008, US experienced the worst financial ever since the Great Depression. Financial institutions in the US received an increase in mortgages and loan defaults especially in the subprime loan. The financial bubble burst. These loans were transferred to other investors or used to guarantee other assets without consideration of the true value of assets and the risks involved. This not only affected the US financial market but also the global financial system was on the receiving it, plunging into a liquidity crisis which accelerated to create a solvency problem. In all this mess, one thing was clear, some individuals and institutions had failed to take due diligence and acted in an unethical manner thereby exposing the unaware market players into the risk that saw many lose their investments and life savings. This paper will seek to provide an ethical critique of the 2008 financial crisis. In this aspect, the paper will present a consequential argument to critique the scenario.

Consequential theory poses two major elements. The first element considers option swith regard to the terms of how much aggregate value their consequences bears. The second element states that an action is right if and only the agent does not have an alternative that would result to a higher evaluative ranking. A consequential theory of value determines the rightness or the wrongness of an action with regard to the consequences resulting from that action. One most applicable theory is the utilitarianism that considers an action to great if the results are the good and for the greatest number. The argument presented in this paper considers the actions of the organizations in the financial system that fueled and escalated the financial system. Following the consequential theory, the actions of these organizations produced negative results that affected the lives of many in a negative manner. These actions can thus be regarded as unethical.

The unethical behavior of organizations

When considering the role of organizations in the ethical breakdown that contributed to the progression of the financial market, I will consider the crisis in leadership, governance and management of organizations ranging from commercial and investment banks, hedge funds, monolines, rating agencies, regulatory and supervisory bodies, the Federal Reserve, and the government in general. The organizations tasked with risk analysis, and management acted in an unethical manner in analyzing the loans especially the subprime loans. The financial institutions changed the mechanism of defining and monitoring risks. The new methods were founded on overly optimistic assumptions that catastrophic events were very unlikely to occur. The consequences of these assumptions were the creation of an illusion that the risk had been removed from the investment portfolio through the credit default swaps. This failed to consider that the risk was reintroduced from other angles. This ended up with no supervision of the systemic risk and elimination of other mechanisms and institutions that had been put in place to monitor the effects. This was the cause of the impending financial disaster (Argondona, 2012).

Another ethical trait that was common among most of the responsible institutions was the creation of incentives for the management of financial institutions. Incentives are normally used to encourage some behavior that may lead to achieving the desired results. In this case, the incentive provided generated unwanted behavior. These incentives prompted the management to act with little consideration of the long-term effects as they aimed to gain the bonus put in place (Argondona, 2012). The managers moved tried to align their interest with the expectations of the shareholders which led to the adoption of compensation systems that were focused on the short-term results. This contributed to the propagation of undesirable behaviors such as excess risk-taking, and manipulation of financial statements and the stock price. The rating agencies were compensated depending on the valuation if clients’ assets. The best analysts were then hired by the clients thereby creating a conflict of interest (Malayendu, 2013).

Another unethical behavior was experienced in the form of regulatory arbitrage. The regulators failed to protect the common citizens who had placed their hopes on them. There were new occurences in legislation such as the removal of Glass-Steagall Act, which had previously separated commercial banking and investment. This Act created incentives for subprime mortgage lending. The companies that undertook this risky trend was under the patronage of the state, most notably Fannie Mae and Freddie Mac. There was a lot of resistance to regulation with financial institution hiring the best lawyers and poaching other regulators to work for them. The regulatory mechanisms that had been placed to protect the financial market ended up being the weakest link that caused its collapse (Mayalendu, 2013).

References

Argondona, A. (2012). Three Ethical Dimensions of the Financial Crisis. Corporate Social Responsibility and Corpeorate Governance Working Paper.

Malayendu, S. (2013). The Ethical Dimension of Financial Crisis in the World of Globalized Finance. MPRA.