Appendix 5 - Inside Job – Shameful Truth behind the Financial Crisis

After watching the award winning film Inside Job, I came away with one question stuck in my mind; how were individuals not held accountable after bringing the global financial industry to its knees, whilst taking millions of dollars in payments in the meantime? What I found even more astonishing than this was that the people involved of the running the failed organisations were then employed by the US government to run and regulate the country’s financial industry.

The film, directed by Charles Ferguson, starts by looking at the level of regulation in America over time. In the 1930s, banks were heavily regulated following the infamous Great Depression.  In 1981, President Ronald Reagan chose the CEO of Merrill Lynch, Donald Regan as Treasury Secretary. This began a 30 year period of financial deregulation, allowing investors to take risks with depositors’ money. By the end of the decade 100’s of loan companies and peoples savings had been lost, consequently costing the taxpayers $121 billion. It doesn’t take a genius to realise this wasn’t the greatest decision ever made.

One interesting point to show how far the levels of deregulation went was the merger between Citicorp and Travellers to form Citigroup. This merger was set to form the largest financial services company in the world however it violated the Glass-Steagall Act (a law passed after the Great Depression). This meant it was illegal for Travellers to be acquired; nevertheless the chairman of the Federal Reserve, Alan Greenspan, said nothing. Citicorp were given a one year exemption and then the law was passed allowing the merger. Straight away this said to me that the most powerful people in the industry could bend the rules to suit them, regardless of the consequences.

Looking back at the financial crisis as a whole, it seems more than likely that the high levels of crime and deception within the industry led the world down the path to adversity. Investment banks were giving inaccurate credit ratings out in public, different to what was being stated privately. In December 2002, 10 investment banks settled a case surrounding this issue for $1.1 billion and promised to change their ways. Since deregulation was introduced, several firms have been caught involved in criminal practices. Citibank helped to funnel $100 million of drug money out of Mexico, whilst Fannie Mae overstated its earnings by more than $10 billion between 1998 and 2003.

By the late 1990s, derivatives had become a $50 trillion unregulated market, despite attempts by the likes of Brooksly Born to bring in some form of regulation. These attempts were blocked, with a lot of the decisions being made by Government officials who had experience of working in the financial industry. Now this seems pretty convenient to me. How could the people who were making the monumental errors in the financial sector be held accountable if those very people had a say in the governing body?

As well as criminal involvement, investment banks combined thousands of mortgages and other loans to create complex derivatives called Collateralised Debt Obligations (CDO’s). These were then sold to investors, with many given the highest rating of AAA. As financial institutions noticed how much money the CDO’s were making, they started to give out riskier ‘sub-prime’ mortgages. Many of the sub-prime lenders were wrongly given an AAA rating, causing investors to believe that they were somewhat risk free investments. Some people may not see the issue with this, and it is all well and good doing this whilst house prices are on the up but as soon as prices begin to fall, massive problems arise.

The main issue was that if people defaulted on these loans when house prices were rising, the costs of this could be recovered. However, when prices were falling there was no way that they costs could be covered and CDO’s had no value. The consequences of this were massive, people who invested in CDO’s lost out big time. Furthermore, people who had issued insurance on these (Credit Default Swaps) had to pay out and AIG for example paid out $61 billion to the owners of the CDS’s the day after they had been bailed out. Having read this blog so far, you may not be surprised to hear that this was another unregulated market and speculators were able to bet against CDO’s which they didn’t own.

During the bubble, investment banks borrowed heavily to buy more loans and create CDO’s, so much so that they were leveraging at up to 33-1. This meant a tiny decrease of 3% in their asset base would leave them insolvent. It seems to me as though investment banks had the intention of trying to make as much money as possible, as quickly as possible, without thinking about the potential consequences. In my eyes Goldman Sachs were the biggest offenders, they bet against their CDO’s with CDS’s, they were selling CDO’s which meant that the more money the customer lost, the more they made. This is unbelievable, and to think that they got away with this is astonishing. Richard Fuld, CEO of Lehman Brothers, managed to take home $485 million despite the collapse of the bank.

To conclude, I believe what has occurred in the US financial market is a disgrace. I would be extremely interested to see what would happen should some of the events occur again. Will regulation prevent the collapse from occurring? The fact that many of the top executives who contributed significantly to the financial crisis were not only able to walk away unpunished, but they kept all their bonuses they had earned whilst running the industry into the ground, is unbelievable.