The financial meltdown of 2008 is the worst debacle we have experienced since the Great Depression. Trillions of dollars in market value disappeared like wisps of smoke; millions of people lost their employment and we are yet to recover. In fact some economies like Spain and Portugal are in the red while others such as Greece have ‘essentially’ collapsed. The truth though is that we saw the symptoms of this financial crisis decades ago. According to Friedman and Friedman (2009) the corporate world had been heading down a dangerous path for more than 20 years. Some of the early warning signs that we ignored were: the Savings and Loan disaster in which 1,043 banks failed at a cost of about $124 billion to U. S.
taxpayers between 1985 and 1995 (Friedman & Friedman, 2009), the dot. com bubble of between 1995 and 2001, the Long Term Capital Management hedge fund fiasco of 1998 and the Enron, WorldCom etc debacles of between 2001 and 2002. Worse still our responses to these failures have been piecemeal legislations such as the Sarbanes-Oxley, financial bailouts and blind faith.
In fact the true cause of the 2008 financial crisis was not a failure of our economic systems but rather a coupling of sloppy regulation together with a meltdown of ethics. In 2001, Enron confessed to have reported erroneous financial statements from 1997 to 2001 to reflect large profits when in fact it had lost a total of $586 million (SarbanesOxleyFocus. com, 2008). The fact that Arthur Andersen LLP, one of the world’s largest accounting firms then, overlooked this was a simple case of values decay and corporate greed. Arthur Andersen was willing to overlook the questionable accounting to retain the large amounts of money it obtained for providing Enron with consulting services.
The lack of external controls to detect this was even more baffling. This was soon enough followed by the WorldCom debacle in 2002, which now prompted the US to come up with the Sarbanes-Oxley Act of 2002. These were two of the more famous cases of financial statements fraud. According to the Association of Certified Fraud Examiners (2008) financial statement fraud occurs when an organisation intentionally publishes false information in any portion of its financial statement with the intention of enhancing the economic appearance of the company.
The management often perpetrate this while the company stockholders, investors and employees are usually kept completely in the dark when such a fraud is taking place. This is one of the major reasons that Khurana and Nohria (2008) say that managers have and continue to lose their legitimacy. They argue for the need of a Hippocratic Oath for managers. Khurana and Nohria (2008) further propose that like other true professions, manager’s require codes of conduct that have meanings and consequences enforced by an oversight governing body made of respected members of the profession.
However, we do not believe that this would be sufficient to help us tackle the financial challenges facing the world today or in the future. When we look at the list Fox (2010) has cited as the twenty five people culpable for the 2008 financial crisis, we would easily have had them as members of Khurana and Nohria’s proposed management code of conducts governing body. When Adam Smith wrote his classic, the Wealth of Nations that self interest + free markets + deregulation would result in prosperity for everyone (Smith, 2009) he believed that economic growth depended on morality.
From his other work, The Theory of Moral Sentiments Smith stated that man ought to regard himself as a citizen of the world to which he should sacrifice his own little interest. As a society we seem to have totally disregarded this. Labaton and Lipton (2008) point a finger at Phil Gramm as the chief architect of the financial crisis of 2008. He was the architect, advocate and the most knowledgeable person in Congress on financial matters considering that he was an Economics academic prior to him becoming a senator. Gramm led the repeal of the Glass-Steagall Act through Congress.
This Act had protected commercial banks from Wall Street by separating them from the risky investment practices at Wall Street. Gramm went further to make sure that a key provision was inserted into the Commodity Futures Modernization Act (2000) that essentially ensured that there was virtually no regulation of the complex financial instruments (Fox, 2010; Labaton and Lipton, 2008) whose collapse would lead to the financial crisis.
This ill-advised lessening of regulations, in the name of free-markets, was aggravated by the actions of the US Federal Reserve and the US Securities Exchange Commission (SEC). Alan Greenspan (ex-chairman Federal Reserve) presumed that financial firms could regulate themselves while Chris Cox (ex-SEC chief) was lax to enforce the commission’s power on big banks. According to Friedman and Friedman (2009) “The S. E.C. agreed to loosen the capital rules and also decided to allow the investment banks to monitor their own riskiness by using computer models to analyze the riskiness of various securities (p. 8)”. We could go on and on to name other ‘significant’ individuals who did not act there part for example President Clinton for signing the Gramm-Leach-Bliley Act and the Community Reinvestment Act that loosened the housing rules or President G.
W. Bush for frustrating Donaldson’s, ex-SEC head’s, drive to boost regulation of mutual and hedge funds. However, the truth is that the American consumer is as much to blame as the lack of regulation. Fox (2010) says that Americans have been living off and believing in the wealth effect.
This translated to a people who believe in living beyond their means through accumulation of debt. Unfortunately, being the world’s biggest economy, other countries quickly adopted similar lifestyles and desires for wealth. David Oddsson, the former Iceland prime minister is a glaring example of one who decided to lead his country through a similar experiment in free-market economics and only succeeded in making the country a case of microeconomic meltdown (Fox, 2010). The 419 Nigerian internet scams and the international lottery scams are all proof of our insatiable desire for quick and easy money.
The financial meltdown of 2008 shows quite clearly what happens when everyone is solely concerned with self-interest (Friedman and Friedman, 2009). Our individual greed contributes to two of three reasons why fraud occurs according to Dr. Donald R. Cressey (Association of Certified Fraud Examiners, 2008), that is: financial and social pressure, and rationalization of fraud activities. The third factor that we have looked at length in this paper is that people commit fraud when there are opportunities of them doing it undetected.
This is where control by regulatory bodies becomes important. Another way of handling the financial crisis of 2008 is viewing it as what Taleb (2007) refers to as a Black Swan. Taleb (2007) states that one of our greater weaknesses as humans is that we are obsessed with the normal to the extent that we are unable to appreciate our inability to control extreme occurrences. We could therefore view the financial crisis as a large deviation from the norm and then from that viewpoint we could then focus on devising preventive measures.
Taleb (2007) encourages us to begin focusing on the extremes, like the Black Swan, because they have extraordinary cumulative effect. After the financial crisis we have witnessed legislation and other activities being made for the financial industry to prevent another meltdown. According to Taleb (2007) this is not the proper way to go because the next big crisis could be something completely different. He proposes that the lessons we learn from this financial crisis should teach us to develop preventive measures for the unusual / the outliers.
References Association of Certified Fraud Examiners. (2008): Nation on Occupational Fraud and Abuse. Retrieved April 24, 2010, from Financial Statement Fraud/Fraud Resources for Fraud 101, http: //www. acfe. com/resources/fraud-101-accounting. asp Davies, Roy. (2010, April). Classic Financial and Corporate Scandals. Retrieved April 20, 2010, from http: //projects. exeter. ac. uk/RDavies/arian/scandals/classic2.html Fox, Justin. (2010, February): 25 People to Blame for the Financial Crisis, Time Magazine. Retrieved May 3, 2010, from http: //www. time. com/time/specials/packages/article/0,28804,1877351_1877350_1877330,00.html#ixzz0omjFVUKm Friedman, H. H. & Friedman, L. W. (2009). The Global financial crisis of 2008: what went wrong?
Retrieved on 29th May 2010 from, http: //ssrn. com/abstract=1356193 Khurana, R & Nohria, N. (2008). It’s time to make management a true profession. Harvard Business Review. October: 70 – 77. Labaton, S & Lipton, E. (2008, Nov. 16). A Deregulator Looks Back, Unswayed. The New York Times. Retrieved May 3, 2010, from http: //www. nytimes. com SarbanesOxleyFocus. com (2008): Corporate Accounting Scandals in 21st Century, Retrieved April 16, 2010, from, http: //www. sarbanesoxleyfocus. com/corporate-accounting-scandals-in-21st-century/ Smith, A. (2009). An Inquiry into the nature and causes of the wealth of nations. Digireads. com. Taleb, N.N. (2007). The Black Swan: The Impact of the Highly Improbable.
New York: Random House Publishing Group. Whitehouse. gov (2008): "Declaration of G20". Retrieved May 5, 2010, from http: //georgewbush-whitehouse. archives. gov/news/releases/2008/11/200811151.html.