Management 1 Assignment II (90:100)
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Transcript of Management 1 Assignment II (90:100)
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Subject Code:
MGMT10002
Subject Name:
Managing and Leading Organisations
Student ID Number:
569082
Student Name:
Joycelyn Vanecia Utomo
Tutorial Day/Time:
Wednesday/9:00 am
Tutor Name:
Austin Chia
Assignment Name or Number:
Essay 2 GFC Analysis
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On September 2008, the bankruptcy of the fourth largest investment bank, Lehman
Brothers, led to a series of systemic risks and triggered the Global Financial Crisis (GFC),
resulting in a recession worst that the Great Depression in 1930s (Enderle, 2009).
According to economists, the main cause of the GFC could be stemmed back to the
unethical practices conducted by different members of large financial institutions, let alone
contributions the US government made through their decisions. Ethics can be defined as
the moral principles that provide a sense of right and wrong for an individual (Robbins,
2012).
The aim of this essay is to argue how poor ethical practices by financial service industries
and the US government led to the GFC, as well as examining its linkages with other
managerial theories. The paper will be structured into three major components in
chronological order; it will begin by exploring the conditions of the external market that
created opportunities for the creation of toxic financial instruments, then evaluate the
response taken by the financial services towards these temptations, and finally discuss the
aftermath of the crisis which includes the inadequate actions by government and
consequences of the crisis to the global economy.
OPPORTUNITY-FILLED ENVIRONMENT
The toxic products that were created by investment banks in Wall Street is said to be the
root cause of the GFC (Enderle, 2010). Nevertheless, the idea of creating these goods
itself first came through opportunities in the external environment. These changes
happening in the market can be further analyzed by the External Environment Framework
that refers to the set of forces or conditions outside the organisation in which an
organisation operates within, impacting the ability of managers to identify opportunities
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and threats and respond to them accordingly (Robbins, 2012). The outermost layer of is
the General Environment, which includes forces such as political, economical, socio-
cultural, and technological just to name a few that has potentials to indirectly influence its
operations and performance over time (Samson & Daft, 2012, 88).
The role of politics in causing the GFC is of utmost importance. After the Great
Depression, the Glass-Steagel-Act was put forth to function as a separator of commercial
and investment bank activities, preventing risky investments with depositors money that
once caused the savings and loans crisis in the past (Michello & Deme, 2012, 105-107).
However in 1999, the bill was abolished, thus starting a period of deregulation (Ferguson,
2009). Insufficient government control not only created a free market where industries
could constantly innovate with dangerous financial instruments, but also legal-loopholes,
meaning that without solid ethical base, although an organisations practice is legal, it may
be unethical.
Despite the fact that Wall Street is notorious for participating in sophisticated criminal
activities when given the opportunity to do so, petitions by regulators were continually
condemned since the industries were backed with large lobby groups and academics that
have the power and resources to influence policy-making (Bernstein & Eisinger, 2010).
Lobbying is the effort to influence government into adjusting policies to benefit the
organisations operations, in exchange with monetary support, such as campaign funds
(Greycourt, 2008). When governments succumbs into these temptations over its risks
towards the nation, it conveys that they decided with Individualist-Approach, an ethical
concept of contending to promote an individuals best long-term interest (Samson & Daft,
2012, 177). In fact, financial lobby groups spent $170 million for the 2008 election, the
year the crisis happened (Gonglof, 2012). Lobbying also managed to influence the
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Securities and Exchange Commissions (SEC) who were supposed to manage risks to
relax leverage limits for investment banks up to 30:1, thus allowing them to borrow heavily
(McKenna, 2009). As Gnaizda stated, its a Wall Street Government! (Ferguson, 2010).
In the US, there is a shared socio-cultural norm on the importance of home-ownership, the
American Dream (Ferguson, 2010). Owning a piece of real estate symbolizes success in
their culture, and politicians have unethically placed pressures and encouraged even
citizens who are less credit worthy with home ownership, by having Government
Sponsored Entities (GSE) to make housing more affordable, in order to gain campaign
support. This is believed to have contributed significantly to the housing bubble, the rapid
growth of home prices (Greycourt, 2008). America also had a stable economic condition,
with low unemployment rate, and to recover from the collapse of the dot-com crisis, the
Federal Reserve (Central Bank) lowered interest rate to 1%, which in turn encouraged
banks to borrow excessively (Petrova, 2009).
On the other hand, Task Environments are forces like competitors and customers that
directly impacts daily operations and overall performances of an organisations. It is
impossible for an industry to ignore these factors as it determines its success (Samson &
Daft, 2012). Financial services in Wall Street are known for being highly competitive since
they were sharing and fighting for the same market share (Schecter, 2010). This puts
pressures on banks to stay agile and forces constant changes in order to keep up with the
pace of its competitors (Rajan, 2009). In an environment that is performance-based, the
big banks developed a High-Achievement Culture, a culture concerned with result-
orientation; valuing competitiveness, aggressiveness, personal initiatives, and encourages
risk-taking to an extreme level that generates improved performances (Samson & Daft,
2012, 115). This type of culture is fueled with rewards, and in the case of the financial
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industries, the amount of bonus received by an employee is determined by the profit they
bring into the organisation. Furthermore, deregulated market intensified the competition
with wrongful product innovation (Olson, 2012).
Continual changes with customer trends also shaped the products and services the
industries offered (Samson & Daft, 2012, 89). In this case, customers refer to
homeowners, investors, and shareholders. In addition to the increase demand for
affordable housing, the ageing population also provided large amount of retirement funds
available for investments, both of which would later impact the choice of market the
financial industries decided on entering. International investors were also brought together
through the exploding use of complex, unregulated financial products known as derivatives
(Rajan, 2009).
TURNING OPPORTUNITIES TO PROFIT
A market with less government interventions, low interest rates, and high leverage
provided industries with the opportunity to take risks and create better financial products in
terms of its profitability. And rapid growth in housing prices attracted the various
organisations into the real estate market. These merely provided opportunities, what the
industries did in respond to these factors came down to their corporate ethics. Before
exploring the concept further, it is necessary to first understand the nature of these
financial instruments and Securitization system developed by the institutions.
Traditionally, when homeowners pays monthly mortgages, money went to their local
lenders, who were careful regarding the credit-worthiness of borrowers since mortgages
usually took decades to repay (Ferguson, 2010). With securitization, lenders sold
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mortgages to investment banks that combines these mortgages with many others
including credit card debts and student loans into complex derivatives known as
Collateralized Debt Obligations (CDO), which are sold to investors (Kirk, 2009). CDOs are
structured financial vehicles that are issued to tranches with varying credit risks and return
profiles. In order to compensate for higher risks, the riskiest parts with subprime loans had
higher interest rates, thus yielding more in return (Adams, 2008, 12-14). Investment banks
then pays Credit Rating Agencies (CRA) to evaluate CDOs, and most of them, even those
consisting subprimes, were given an AAA rating, the safest government securities
possible, making it popular with retirement funds that were only made sound investments
(Davidson, 2010).
As CDOs became popular in early 2000s, this signals lenders to pump up volume of loans
to obtain more mortgages. This was achieved through easy lending, where most loans
were given to borrowers with poor creditworthiness and insufficient documentations, and
not surprisingly, would default. These mortgages had misleading terms that after several
months would alter teaser rates and increase payments drastically. By 2006, the amount
of subprimes funds issued worth $600 billion (Ferguson, 2010). With this new system,
default imposed no risk to any party, since lenders could retain houses back if it goes to
default then sell it off quickly to the hot market. Investment bankers did not care either,
the more CDOs sold, the higher their year-end bonuses. And if valuation by rating
agencies proved wrong, there were no liabilities against them since these were based on
opinions (Monjonnier, 2012)(Rajan, 2009).
AIG, the largest insurance company, produced another dangerous derivative, the Credit
Default Swap (CDS). With CDS, owners, and even speculators could insure CDOs, and if
it fails, AIG promised to cover its losses. This is an extreme risky gamble since the degree
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of loss would become proportionately higher. When the housing bubble later inflated, the
banks began betting against the failure of CDOs with CDS, including the ones they issued
themselves, without consulting this information with their investors (Petrova, 2009). This
proves that the industries were aware of the threats they were imposing to the
stakeholders and community. The organisations were unable to manage transparency,
the degree which an organisation shares information with its stakeholder public. While
operating in secret, and not acting with the best interest of their clients and shareholders,
organisations are clearly defying trust (Robbins, 2012).
Although drawing in large profits during the bubble, what securitization does is pass on the
risk of default from one part of the chain to the next, and employees were rewarded with
large bonuses based on these short-term revenue (Bencivega, 2009). The large financial
industries had a mentality of being too-big-to-fail, meaning that if there were threats in
their business, the government will eventually have no choice but to bail them out, and
there will be no legal charges since legal-loopholes existed through deregulation (Rajan,
2009). In fact, those who will pay the largest price if there were a failure in the market
would be borrowers and investors (Ferguson, 2010).
These business practices were legal, however, when industries are able to predict the
potential harm and refused to change its way, it question their ethics. Unethical behaviors
occur when decisions enable the organisation to gain at the expense of society. Decision-
making and Business Ethics coexist, dealing with internal values that are part of corporate
culture and shapes decisions concerning social responsibility with respect to the external
environment. These internal values of the environment consist of three key aspects
employees, management, and culture (Samson & Daft, 2012, 88&175). Corporate culture
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refers to the set of values and beliefs that strongly influence employee behavior and
management (Weber, 1995).
An organisation with an ethical culture are one that adopts strong Corporate Social
Responsibility (CSR), which can be defined as the obligations to make choices and
actions that will contribute to the welfare and interests of not only the company itself, but
also the organisation. In the CSR pyramid framework, there are four main responsibilities
an organisation must be mindful of from the most significant to the least; economic, legal,
ethical, and voluntary (Samson & Daft, 2012, 183&191). Nevertheless, the series of
decisions taken by the various financial industries interprets that their only goal was profit
maximizing. Just as discussed of their high-achieving culture, the large incentive system
that were based on performances corrupted ethical decision making within the companies.
Between 2003-2011, Wall Street paid out $200 billion on bonuses alone, and those
benefiting from this privilege are only those seated on the top management positions
(Gonglof, 2012). Studies by Sucharow showed that majority of Wall-Streeters believed
unethical behavior helps promote their success, and compensation structures created
temptations in compromising their ethical standards and even violate laws if they could get
away with it, which is exactly what legal-loopholes made possible (Alden, 2012).
Codes of ethics in cultures are shaped through Leaders (senior managements and CEOs)
since they act as a role model or organisational heroes that inspire the company,
standardising practices and behaviors that are acceptable and intolerable. However, when
leaders send out the wrong message to employees like rewarding unethical acts this
signals that these behaviors are cheered on. Studies showed that despite displaying
Charismatic Leadership leading with energy and eagerness to employees, and are well
liked and inspiring, senior managers in Wall Street are ego-driven, acting at their best
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interest of personal greed, willing to take unethical risk in order to pursuit financial rewards,
and to the extent of manipulating their stakeholders (Boddy, 2011)(Samson & Daft,
2012,192). The main sources of powers these leaders possess of are rewarding, which is
punishing and control, and referent, being admired that it inspires loyalty (Samson & Daft,
2012, 193-194). Nevertheless, these powers would not have manifested since the only
power leaders have over employees are determined by the power workers return to them.
Therefore, it could be said that the culture encouraged each members involved being
willing accomplices. As the industries went out of control from dangerous incentives, it did
not take long for them to destroy their own organisation from the inside.
THE CRISIS AND AFTERMATH
As unregulated derivatives and subprimes practices became excessive, default rates
increased and borrowers were facing foreclosure. By 2007, the bubble crashed and the
real values of CDOs filled with subprimes were being exposed. The investment banks had
too many of these toxic assets they were unable to sell and began running out of cash. By
mid-2008, the industries began to drop in stock prices because consumer started loosing
confidence in the market, and Bear Stearns and the GSEs were the first to hit turbulence
(Jones, 2012).
This came as a shock to the Federal Reserve, as they were unprepared and had no
Contingency Planning, which is defined as an organisation plan for response to
emergency and unexpected conditions. Despite numerous warnings regarding the danger
of financial practices during the bubble, the government did not plan in advance, which
would have aided their decision-makings. The government was aware that the failures of
Bear and the GSEs would cause a domino effect on the banking system. However, if they
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were to be bailed, it would cost taxpayers money, raising ethical concern on the banks
being rescued for their own wrongdoings (Donaldson, 2012). This caused an ethical
dilemma for the government, meaning both alternative choices are undesirable because of
negative ethical consequences (Samson & Daft, 2012, 176).
The government took the Utilitarian approach, an ethical concept that the decision
produces greatest good for the greatest number of people (Samson & Daft, 2012, 177).
Bear was forced into being acquired, backed with $30 billion of taxpayers money to heal
their balance sheet. Before even recovering from bailout exhaustion, Lehman also started
fluctuating, but was allowed to fail in order to punish the banks (Williams, 2008). This was
based on the Justice Approach that decisions must be based on standards of equity and
fairness (Samson & Daft, 2012, 178). Nevertheless, lack of contingency planning and
situational leadership backfired, causing a systemic risk. If the government were more
prepared, they would have predicted that failure of Lehman would stop interbank lending
and freeze the market, leading to the collapse of AIG who had issued numerous CDS
insuring Lehmans CDOs, causing more bailouts, totaling $700 billion in 2008,
nevertheless too late too overturn the crisis (Donaldson, 2012).
In result, the global economy became destabalised as unemployment rose. As consumers
lost their buying power, many industries went out of business. This reached a global scale
since the banks operated in several countries, and foreigners who invested on CDOs also
experienced the market failure. In the end, only the senior managements and CEOs of the
big banks were able to escape the crisis, keeping the bonuses they earned throughout
the years (Donaldson, 2012).
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THE BLAME GAME
The securitization chain and poor government decisions led to the worst recession in
history, and this questions who is to be blamed: the government, subprime lenders,
investment banks, or CRA? Notwithstanding, they were all willing accomplices, where if
one had made the choice to change their ways, it would have stopped the flow of funding
into the system immediately, but profit was apparently above people.
In conclusion, this essay has explored the GFC, from the external environment that
created opportunities for financial service industries, the corrupted internal environment
the various institutions displayed, and poor planning and ethical dilemmas by the
government. Although some argued that these doings are ethical since investors and
home buyers must be responsible for their business decisions, the fact that the industries
and their monopoly over government has placed millions in foreclosure, unemployment,
and wrecked the global economy, proves that the crisis was indeed a crisis of ethics.
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