Position of the Iceland Economy Before and After Deregulation: Inside Job - Movie Review Example

You’re 2-Sep-16 Inside Job Introduction The documentary Inside Job is based on the late 2000 global financial crisis and is segregated into five key parts. The key aim of the documentary is to illustrate the background and modalities of the global recession to the masses who find it impossible to comprehend the confusing complex financial terms and derivatives terms used by commentators to describe the crisis. The documentary starts with a brief look at how Iceland was highly deregulated in 2000 and its banks were privatized. When Lehman Brothers went bankrupt and AIG collapsed on September 15, 2008, Iceland and the rest of the world went into a global recession. Position of the Iceland economy before and immediately after deregulation "Inside Job" begins not on United States’ Wall Street but in Iceland, a nation whose complications produce to be the worlds in small-scale version. Ferguson’s documentary looks into how this small country, with an impressive gross national product of $13 billion, ended up with bank losses of over $100 billion? Ferguson found the root of Ireland’s problems to be the privatization of the three largest banks directed into a borrowing spree that headed to disaster. Before deregulation, Iceland was cruising towards prosperity. Iceland had an unexpected bubble, highly felonious. One of the individuals who was interviewed for the film, the former prime minister of Iceland, was recently impeached, which caused a gargantuan bubble. There was a colossal financial bubble, and it inaugurated to vacillate around 2006. And the Icelandic banks took many strides to keep sustaining it, and one thing that they did was they had the Icelandic chamber of commerce commission reports from prominent American and European academics saying everythings wonderful. The international environment preceding the crisis was characterized by globally stable economic growth, growth of productivity and a low level of inflation - which was a primary result of policy changes by central banks focused on inflation targeting. Short term interest rates were at historically low levels both in the US and worldwide. Due to the recession in 2001 the US Federal Reserve Board (Fed) introduced a sharp decrease in its target interest rate. Even though this resulted in the recovery of the economy, figures remained weak, not showing signs did not of a substantial GDP growth or growth of employment, at least until 2005. In addition to this "jobless recovery" there were threats of a decrease in inflation, which was already at very low levels and a serious concern that the US might experience a recession decade, like that endured in Japan in the 90s. Even after tightening of the monetary policy in 2004 real rates still remained rather low. The role of the major banks in setting the foundations for the crisis Ferguson titled the first part of the documentary "How We Got Here", wherein he shifts the documentary from Iceland to the United States of America and then explained that the United States’ financial industry had been properly regulated during 1940 to 1980 which was later followed by a prolonged period of deregulation. Ferguson stated that the to explain the roots of the Global Financial Crisis to the early 1980′s when during the Reagan government regime a deregulating bill was being passed for the banking and finance industry, but it was greatly watered down bill was enacted wherein a number of government acts and regulations that came into force after the Great Depression of the early 1930′s. Ferguson regretted that despite the downfall of savings and loan associations in late 1980s, the loud and clear warning that something wasnt right in the finance industry was left unheard and unaddressed, which resulted in continuation of the massive deregulation spree, which went on well into the next decade. In order to convert mortgage and other types of loans into more money-spinning financial instruments, the financial wizards and mathematicians devised many creative ways which were backed by other weird, wonderful and wacky financial products whose beginnings were dissimilar and complex even for finance industry workers to trace. These products were created by mathematicians, physicists and others with science-oriented degrees that treated the stock market as though it were an enormous casino. Eventually a catastrophe of trust and confidence had settled in and was spread like a wildfire, destabilizing large corporations like Bear Stearns, AIG and Lehman Brothers which eventually ended up being taken over by large banking corporations, and the US government under President George W Bush was forced to bail out Wall Street for US$700 billion. At the conclusion of late 1980s, a savings and loan crisis had caused an expense for the American taxpayers to the upward tune of about $124 billion. Subsequently in the late 1990s, the financial sector had amalgamated into a few giant firms. At the beginning of the 21st century, the Internet Stock Bubble burst due to the false promotion by investment banks of Internet companies that they knew sure would not be successful, resulting in an estimated $5 trillion in investor losses. As derivatives gained popularity in the industry and added unpredictability. Efforts to regulate derivatives were frustrated by the Commodity Futures Modernization Act of 2000, backed by several key officials. In the 2000s, the industry was subjugated by five investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, and Bear Stearns), two big financial conglomerates (Citigroup, JPMorgan Chase), three securitized insurance companies (AIG, MBIA, AMBAC) and three rating agencies (Moody’s, Standard & Poors, Fitch). By this time, the subprime mortgage market in the United States of America was comparatively small in size and it was supported generally by commercial and investment banks whose objective was to purchase these mortgages from underwriters, repackage them into mortgage-backed securities (MBSs) and sell them to investors while sponsored by the payment of principal and interest on the underlying mortgages. These MBSs were designed by classes with the same guarantee but an altered level of risk. These repackaged loans were subsequently bought by investors whose interest was the return on the initial investment in the form of interest payments on the mortgages paid by the mortgage owners. As this trend of repackaging mortgage loans (and other loans) into other complex financial instruments for re-selling to investors began to pick up, a crisis started brewing when in the United States in the housing and mortgage market began to move upwards where people were buying and selling houses in the hope of profiting from them. In order to meet their greedy objectives, they continued to invest predominantly borrowed money for buying real-estate as the safest possible investment whose price was almost certainly proving to be constantly increasing. This activity increased demand of the housing market which further fueled the prices hike of real estate and thus the financial institutions increased their credit expansion in these fields by lowering their lending standards to encourage more customers and by decreasing the interest rates at which they provided this credit. This massive cycle of credit taking and credit issuance for rising property prices resulted in two key effects: it increased the debt of conventional households and it increased the banks petition for other sources of financing. The dearth of bank’s own sources was remunerated for by borrowing from other lending institutions until the debt amount became unsanctionable, i.e. when it could not be paid out of its own capital. The Subprime loans led to predatory lending, i.e. many home owners who were unable to repay were given loans nevertheless. This was done in order to improve profitability of the Bank who was unconcerned about the financial health of the home owners as the banks insured their loans using a derivative called Collateralized Debt Obligation (CDOs). The role of the reserve bank, financial regulators and auditors in the prevention of the crisis The financial regulators and auditors seemed to ignore the massive problems brewing by the leading banks and funds. The reserve banks and financial regulators did not object to the massive gambling by banks on depositor’s money and the auditors continued to give green signals to such loans and derivatives. Ferguson studied this activity and discovered that this was largely due to the fact that most of the key people in these organizations were old bank employees, their friends, family or relatives. Additionally these regulators were given heavy monetary benefits by the leading banks which fueled the ignorance of the regulator and reserve banks, leading to the global financial crisis. Greed and corruption were the most widespread two causes that are being blamed for the risky behavior of banks and other financial institutions. While no one contradicts the existence of these intentions, as they are always present, there is no confirmation that they climaxed in 2007-2008 and caused the crisis. The financial institutions capitalized into only the safest securities with an AAA rating, as determined by the authorized rating agencies and rated as securities with the minimum risk and therefore the lowest return, effectively turning them equilivant to government treasury quality Collapse of Lehman Bros, Merrill Lynch, AIG and other financial giants Ferguson showed that at the end of the first quarter of 2008 the total securitized mortgage market was worth US$7.39 trillion in outstanding balances, making it the biggest debt market, with a total share of 24.21%. By June 22, 2007 it was evident that the financial sector was in deep trouble when Bear Stearns was forced to save two of its hedge funds heavily invested in subprime CDOs with a US$3.2 billion bailout. The problem as stated by Ferguson was that nobody knew the true extent of the subprime exposure among the US investment banking sector, and therein lay the lack of confidence in investment banks that led to a shareholder run on Bear Stearns and Lehman Brothers and their eventual collapse. Ferguson said that even at the time of its sale on Sunday, Bear Stearns capital, and its broker-dealers capital, exceeded supervisory standards. Counterparty withdrawals and credit denials, resulting in a loss of liquidity - not inadequate capital - caused Bears demise. This basically translated into the fact that the creditors were unwilling to give Bear Stearns any more credit. Ferguson said that as investment banks relied on high leverage to raise capital. The exposure to "bad" assets was a leading factor in the loss of confidence in the interbank credit system. On September 15, 2008 Lehman Brothers announced its intention to file for Chapter 11 bankruptcy (Lehman Brothers (2008c)). This would make it the biggest bankruptcy in the history of corporate America, with total assets of US$600 billion and liabilities of approximately US$571.56 billion on equity of US$28.44 billion (Lehman Brothers (2008b)), with a total mortgage exposure of US$45.8 billion (Lehman Brothers (2008c)). On the same day Merrill Lynch reported that it had agreed to a US$50 billion all-stock takeover by Bank of America (Merrill Lynch (2008)). On September 21, 2008, the era of the Wall Street investment banks as it was known came to an end when Goldman Sachs and Morgan Stanley converted to bank holding corporations. Goldman Sachs and Morgan Stanley both indicated that the potential to access Federal Reserve funding and to use depositors as additional sources of capital were the main reasons behind the conversion. Inside Jobs says that both institutions knew that the investment banking sector could no longer survive in its present form due to the high leverage requirements and both needed the backing of the Federal Reserve for funding for the foreseeable future. Role of “Securitization” of bonds and derivatives in the crisis The leading Investment banks started to bundle their mortgages with other loans and debts into collateralized debt obligations (CDOs), which they sold to investors. Rating agencies choose to give many CDOs AAA ratings. Due to the many complexities of the mortgage securities, e.g., MBSs and CDOs, at the heart of the crisis, the issuers were keen to obtain rating scales similar to bonds. The difficulty was that the tranched nature of these securities made it a long and complicated process and meant rating agencies were involved from the origination stage. This was due to the necessity of selecting assets with the correct ratings for each tranche. This implied that these securities had ex ante ratings, as opposed to the traditional ex post method of ratings. Rating agencies and the Financial Crisis Credit rating organizations, such as Moody’s, Standard and Poor, and Fitch, played an important role in the securitization process as they rated the pools of mortgages with regard to their risk, which served as the basis for the risk assessment of investors and regulators. Prior to the financial crisis, rating organizations assumed unrealistically low expected losses on subprime mortgage-based securities pools and failed to revise them upward in time, despite the high growth of subprime mortgages and changes in the population of originators and borrowers, both of which should have been causes for concern. The rating agencies were, like Fannie and Freddie, privately owned companies that enjoyed large government benefits. A large amount of institutional investors such as retirement funds, insurance companies and banks were forbidden to purchase securities with a lower rating than BBB as determined by the recognized rating agencies. The regulator in certain cases allowed only the purchase of highest AAA rated securities creating thus a favorable market for credit rating agencies. In 1975 a government regulating agency, Securities and Exchange Commission (SEC), gave an oligopoly status to three rating agencies in the US. Standard & Poors, Moodys and Fitch became the only agencies that had the right to give out official ratings to various market securities. They were set as NRSROs (Nationally Recognized Statistical Rating Organizations) and they were the only ones good enough to comply with SECs regulatory requirements in order to evaluate the riskiness of a security. Accountability for the Crisis Unfortunately accountability for this crisis has not been done, rather the perpetuates have been rewarded extensively for their looting spree. The fact that bank investments, government policies and government sponsored enterprises were guiding the decisions of market participants, it could be inferred that the global financial crisis was caused by regulation, or better yet by failed government intervention on the market. Fannie Mae and Freddie Mac were included in the political decisions of the American government for obtaining its political goal of expanding the availability of loans for buying houses to all social groups, especially to low-income minorities. The risk was becoming inherent to them by the dictate made by government policies, which was to escalate in the case of a recession or falling housing prices. The first to be hit by this possible recession were the social groups with low and unstable incomes. The regulatory decisions demanded from Fannie and Freddie a repurchase of mortgage loans and securities from those who could not have made regular down payments. This was all due to the pursuit of a populist government policy - that everyone is entitled to a home, with no regard to their income, as the fight against homelessness and poverty leads to election success, disregarding the long run effect. A lot of taxpayer’s money has been used to bail out the failed organizations and big banks but no person or institution has yet been even charged for the crimes committed to the tune of billions of dollars. Till date the regulators and lawmakers are still highly influenced by the perpetuators of these acts and prompt and effective action against the looters is highly unlikely even now. Works Cited Ferguson, Charles H; dir. Inside Job. Sony Pictures Classics, 2010. Documentary Film Read More