1. Who Kill the Bull of Wall Street?
From the Ethical Viewpoint
Professor Andrew B.C. Huang
g
Doctor Max Chin
Management School, 2008 Winter

2. China Export Tainted Milk, and US Export Tainted Debt
“Subprime is Wall Street's
euphemism for junk.”
— Allan Sloan, How Financial Madness Overtook Wall Street, TIME,
次貸是華尔街垃圾債卷的華丽代名詞
And till now, its’ fires keep burning in the world financial
markets, and still nobody can measure
k t d till b d
how big the black hole is?
US$ 60 trillion? Or 600 trillion?

3. Causes of The Credit Crisis
The storm has been manipulated and diversified
Homeowners
central bank
the inability to make
policies
mortgage payments
regulation
Government Borrower/ Lender
financial innovation that poor judgment
distributed default risks false finance
Liquidity crisis emerges
August 9, 2007
Market
speculation and
high personal and
overbuilding
corporate debt levels
during boom period
risky mortgage Securitization
products

4. Subprime Mortgage Crisis
Rising From the Most Greedy Financial Package
• The subprime mortgage crisis is an ongoing financial crisis characterized by contracted liquidity
in global credit markets and banking systems. A downturn in the housing market of the United
States, risky practices in lending and borrowing, and excessive individual and corporate debt
levels have caused multiple adverse effects on the world economy.
• The crisis, which has roots in the closing years of the 20th century but has become more apparent
throughout 2007 and 2008 h passed th
th h t d 2008, has d through various stages exposing pervasive weaknesses i
h i t i i k in
the global financial system and regulatory framework.
• The crisis began with the bursting of the United States housing bubble and high default rates on
quot;subprimequot; and adjustable rate mortgages (ARM), beginning in approximately 2005–2006. For a
number of years p
y prior to that, declining lending standards, an increase in loan incentives such as
g g
easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to
assume difficult mortgages in the belief they would be able to quickly refinance at more favorable
terms. However, once interest rates began to rise and housing prices started to drop moderately
in 2006–2007 in many parts of the U.S., refinancing became more difficult.
• Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices
failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in
the United States in late 2006 and triggered a global financial crisis through 2007 and 2008.
During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up
79% from 2006.
• Major banks and other financial institutions around the world have reported losses of
approximately US$435 billion as of 17 July 2008. In addition, the ability of corporations to obtain
funds through the issuance of commercial paper was affected. This aspect of the crisis is
consistent with a credit crunch. The liquidity concerns drove central banks around the world to
intervene by bailing out defaulting financial corporations in order to encourage lending to worthy
borrowers at the expense of taxpayers
taxpayers.

5. The Most Complex Finance Engineering
Borrowing Under a Securitization Structure

6. Subprime Lending Isn’t Easy Money
p g y y
There Is No Free Lunch
• Subprime lending is the practice of making loans to borrowers who do not
qualify for market interest rates owing to various risk factors, such as
income level, size of the down payment made, credit history, and
employment status.
• The value of U.S. subprime mortgages was estimated at $ $1.3 trillion as of
March 2007,with over 7.5 million first-lien subprime mortgages outstanding.
Approximately 16% of subprime loans with adjustable rate mortgages (ARM)
were 90-days delinquent or in foreclosure p
y q proceedings as of October 2007,
g ,
roughly triple the rate of 2005. By January 2008, the delinquency rate had
risen to 21% and by May 2008 it was 25%.
• The U.S. mortgage market is estimated at $12 trillion with approximately
9.2%
9 2% of loans either delinquent or in foreclosure through August 20082008.
Subprime ARMs only represent 6.8% of the loans outstanding in the US, yet
they represent 43.0% of the foreclosures started during the third quarter of
2007. During 2007, nearly 1.3 million properties were subject to foreclosure
filings,
filings up 79% versus 2006
2006.

7. Speculation
Everyone Looks for Easy Money
• Speculation in real estate was a contributing factor During 2006 22% of homes purchased (1 65
factor. 2006, (1.65
million units) were for investment purposes, with an additional 14% (1.07 million units) purchased
as vacation homes. During 2005, these figures were 28% and 12%, respectively. In other words,
nearly 40% of home purchases (record levels) were not primary residences. NAR's chief
economist at the time, David Lereah, stated that the fall in investment buying was expected in
2006. Speculators
2006 quot;Speculators left the market in 2006, which caused investment sales to fall much faster than
2006
the primary market.quot;[32]
• While homes had not traditionally been treated as investments like stocks, this behavior changed
during the housing boom. For example, one company estimated that as many as 85% of
condominium properties purchased in Miami were for investment purposes. Media widely reported
the behavior f
th b h i of purchasing condominiums prior t completion, th quot;fli i quot; ( lli ) th
h i d i i i to l ti then quot;flippingquot; (selling) them f a
for
profit without ever living in the home.[33] Some mortgage companies identified risks inherent in
this activity as early as 2005, after identifying investors assuming highly leveraged positions in
multiple properties.[34]
• Keynesian economist Hyman Minsky described three types of speculative borrowing that can
y y y yp p g
contribute to the accumulation of debt that eventually leads to a collapse of asset values:[35][36]
the quot;hedge borrowerquot; who borrows with the intent of making debt payments from cash flows from
other investments; the quot;speculative borrowerquot; who borrows based on the belief that they can
service interest on the loan but who must continually roll over the principal into new investments;
and the quot;Ponzi borrowerquot; (named for Charles Ponzi), who relies on the appreciation of the value of
their assets (e.g. real estate) to refinance or pay-off their debt but cannot repay the original loan.
• The role of speculative borrowing has been cited as a contributing factor to the subprime
mortgage crisis

8. High-risk Loans
Higher-risk Loans to higher-risk Borrowers
• September 18, 2008A variety of factors have caused lenders to offer an increasing array of
higher-risk loans to higher-risk borrowers. The share of subprime mortgages to total originations
was 5% ($35 billion) in 1994,9% in 1996, 13% ($160 billion) in 1999, and 20% ($600 billion) in
2006.
• A study by the Federal Reserve indicated that the average difference in mortgage interest rates
between subprime and prime mortgages (the quot;subprime markupquot; or quot;risk premiumquot;) declined from
2.8 percentage points (280 basis points) in 2001, to 1.3 percentage points in 2007. In other words,
the risk premium required by lenders to offer a subprime loan declined. This occurred even though
subprime borrower and loan characteristics declined overall during the 2001–2006 period, which
p g p
should have had the opposite effect. The combination is common to classic boom and bust credit
cycles.
• In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan
options and incentives. These high risk loans included the quot;No Income, No Job and no Assetsquot;
loans, sometimes referred to as Ninja loans.
• Another example is the interest-only adjustable-rate mortgage (ARM), which allows the
homeowner to pay just the interest (not principal) during an initial period. Still another is a
quot;payment optionquot; loan, in which the homeowner can pay a variable amount, but any interest not
paid is added to the principal. Further, an estimated one-third of ARM originated between 2004
and 2006 had quot;teaserquot; rates below 4% which then increased significantly after some initial period
teaser 4%, period,
as much as doubling the monthly payment.loans to people who don't have Social Security
numbers.

9. Misrepresentation of loan application data and mortgage fraud are other contributing
factors. US Department of the Treasury suspicious activity report of mortgage fraud
increased by 1,411% between 1997 and 2005

10. Other Economic Effects
Credit and Liquidity Tighten in A Sudden
• Housing price declines left consumers with less wealth, which placed
downward pressure on consumption.
• Certain minority g p received a higher p p
y groups g proportion of subprime loans and
p
experienced a disproportional level of foreclosures.
• Home related crimes including arson increased.
• Job losses in the financial sector were significant, with over 65,400 jobs lost
in the United States as of September 2008
2008.
• Many renters became innocent victims, often evicted from their homes
without notice due to foreclosure of their landlord's property. In October
2008, Tom Dart, the elected Sheriff of Cook County, Illinois, criticized
, , y, ,
mortgage companies for their actions, and announced that he was
suspending all foreclosure evictions.
• The sudden lack of credit also caused a slump in car sales. Ford sales in
October 2008 were down 33 8% from a year ago General Motors sales
33.8% ago,
were down 15.6%, and Toyota sales had declined 32.3%. One in five car
dealerships are expected to close in Fall of 2008.

11. Which Report is Truth
Criminal Deceptions Easy to Find in Subprime Lending
• The Center for Responsible Lending in its report on IndyMac related testimony that
Lending, IndyMac,
the bank actually made efforts to avoid having income information about some
borrowers.
• The Associated Press has reported that a federal grand jury (chosen body of 12 to
decide whether enough evidence to justify a trial) is investigating subprime lenders
Countrywide Financial Corp., New Century Financial Corp. and IndyMac Bancorp Inc.
and reports also that the FBI is investigating IndyMac for possible fraud (criminal
deception, person or thing that deceives)
• The question then is whether banks and other private mortgage originators of
question, then,
subprime and other quot;nonprimequot; loans might deliberately have profited or attempted to
profit - in moneys, economic benefit or even fraudulent gain - through reducing the
amount of information they collected from borrowers.
• Judge Leslie Tchaikovsky of the U.S. Bankruptcy Court for the Northern District of
g y p y
California, found on 25 May 2008 that even though a pair of borrowers had, indeed,
misrepresented their incomes on a quot;stated incomequot; home equity loan, National City
Bank's quot;reliancequot; on these statements of income quot;was not reasonable based on an
objective standardquot;.
• The banking industry provided home loans to undocumented immigrants, viewing it
as an untapped resource for growing their own revenue stream.

12. Number of U.S. Household Properties
Subject to Foreclosure Actions by Quarter
Foreclosure: Use the right to take possession of property

13. Subprime Mortgage Crisis Chain
And Its’ Impact still Unknown yet

14. 2008 Will Be Better Than 2007
008 e e e a 00
Who Knows and Who Scares

15. Who Can Give a Hand
to Maintain a Looser Credit Policy

16. Who Understand the Risks?
Securitization Process
• Traditionally,
Traditionally banks lent money to
homeowners for their mortgage
and retained the risk of default (fail Collateralized Debt Obligations
to pay a debt), called credit risk. Sharing Risk? Or Died Together?
• However, due to financial
innovations, banks can now sell
rights to the mortgage payments credit risk
and related credit risk to investors,
,
through a process called
securitization. counterparty risk
• The securities the investors asset price risk
purchase are called mortgage
backed securities (MBS) and
collateralized debt obligations liquidity risk
(CDO). This new quot;originate to
distribute
distributequot; banking model means
credit risk has been distributed
broadly to investors, with a series
of consequential impacts.

17. The Market Mechanisms
affecting corporations and investors
• There is a greater i
Th i interdependence now than i the past b
d d h in h between
the U.S. housing market and global financial markets due to
MBS( Mortgage Backed Security).
• When homeowners default (fail to perform a duty), the amount of
cash flowing into MBS declines and becomes uncertain.
• Consequently,
Consequently investors and businesses holding MBS have been
significantly affected. The effect is magnified by the high debt levels
maintained by individuals and corporations, sometimes called
financial l
fi i l leverage.
• The mechanisms through which a decline in housing prices will
further affects all market participants.
p p

19. 2003 SEC Litigation
• In 2003, Lehman Brother was one of ten firms which simultaneously entered
into a settlement with the U.S. Securities and Exchange Commission (SEC),
the Office of the New York State Attorney General and various other
y
securities regulators, regarding undue influence over each firm's research
analysts by their investment-banking divisions.
• Specifically, regulators alleged that the firms had improperly associated
analyst compensation with the firms' investment-banking revenues and
firms investment banking revenues,
promised favorable, market-moving research coverage, in exchange for
underwriting opportunities.
• The settlement, known as the “global settlement”, provided for total financial
penalties of $1.4 billion including $80 million against Lehman and
$1 4 billion, Lehman,
structural reforms, including a complete separation of investment banking
departments from research departments, no analyst compensation, directly
or indirectly, from investment-banking revenues, and the provision of free,
independent, thi d
i d d t third-party, research t the firms'' clients.
t h to th fi li t

20. The Headaches Might Jus Begin
e eadac es g Just eg
Who Can Escape From the Supply-Demand Rule?

21. Even So, Never Forget Bonus
Top People’s Annual Income Always 100 Million
• Just before the collapse of Lehman Brothers executives at Neuberger
Brothers,
Berman sent e-mail memos suggesting, among other things, that the
Lehman Brothers' top people forgo (give up) multi-million dollar bonuses to
quot;send a strong message to both employees and investors that management
is not shirking (a id responsibilit ) acco ntabilit for recent performance quot;
(avid responsibility) accountability performance.quot;
• Lehman Brothers Investment Management Director George Herbert Walker
IV, second cousin to U. S. President George Walker Bush, dismissed the
p p
proposal, g g so far as to actually apologize to other members of the
, going y p g
Lehman Brothers executive committee for the idea of bonus reduction
having been suggested. He wrote, quot;Sorry team. I am not sure what's in the
water at Neuberger Berman. I'm embarrassed and I apologize.quot;
• On October 6, 2008, CEO Richard Fuld testified before Congress. Rep
6 2008 Congress Rep.
Waxman pointed out that Fuld had made nearly $0.5B since 2000, a salary
incomprehensible to the average taxpayer, while Fuld was guiding Lehman
to bankruptcy. Waxman said to Fuld, quot;My question is a simple one. Is this
fair?
fair?quot; Fuld did not give a straight answer to the question but only a
question,
meandering reply.

22. CEO Richard Fuld
Model of Greed and incompetence
• L h
Lehman B th
Brothers H ldi
Holdings A Announced it would fil f
d ld file for
Chapter 11 bankruptcy protection, citing bank debt of
$
$613 billion, $
, $155 billion in bond debt, and assets worth
,
$639 billion.
• The morning of September 15 2008, witnessed scenes
of Lehman employees removing computers, fil
fL h l i t files, it
items
with the company logo, and other belongings from the
world headquarters a 745 Se e
o d eadqua e s at 5 Seventh Avenue. e ue
• The spectacle continued throughout the day and into the
following day. Some also signed a large pencil-drawn
picture of CEO Richard F ld many of th
i t f Ri h d Fuld, f them d
denouncing i
him for greed and incompetence.

23. The Annotated Fuld
Geoffrey Raymond put his portrait of Fuld outside the Lehman offices in
New York for staff to post their comments

24. Conflict of interest
Fannie/ Freddie: classic examples of crony capitalism
• Government backing let Fannie and Freddie dominate the mortgage underwriting
mortgage-underwriting.
quot;The politicians created the mortgage giants, which then returned some of the profits
to the pols - sometimes directly, as campaign funds; sometimes as quot;contributionsquot; to
favored constituents.quot;
• On April 18 2006 home loan giant Freddie Mac was fined $3 8 million by far the
18, 2006, $3.8 million,
largest amount ever assessed by the Federal Election Commission, as a result of
illegal campaign contributions. Much of the illegal fund raising benefited members of
the United States House Committee on Financial Services, a panel whose decisions
can affect Freddie Mac, but also benefitted Republican p
, p politicians in g
general.
• Some lawmakers received favorable treatment from financial institutions involved in
the subprime industry. In June 2008 Conde Nast Portfolio reported that numerous
Washington, DC politicians over recent years had received mortgage financing at
noncompetitive rates at Countrywide Financial because the corporation considered
for th ffi h ld
f the officeholders under a program called quot;FOA'squot;--quot;Friends of Angeloquot;.
d ll d quot;FOA' quot; quot;F i d f A l quot;
• Angelo being Countrywide's Chief Executive Angelo Mozilo. On 18 June 2008, a
Congressional ethics panel started examining allegations that chairman of the Senate
Banking Committee, Christopher Dodd (D-CT), and the chairman of the Senate
Budget C
B d t Committee, K t Conrad (D ND) received preferential l
itt Kent C d (D-ND) i d f ti l loans b t bl d
by troubled
mortgage lender Countrywide Financial Corp.
• Two former CEO of Fannie Mae Franklin Raines and James A. Johnson also
received preferential loans from the troubled mortgage lender.

25. Ethics Investigation
Countrywide financial political loan scandal
Chairman of th S
Ch i f the Senate Banking
t B ki Chairman of th S
Ch i f the Senate Budget
t B d t
Committee Christopher Dodd (D-CT) Committee Kent Conrad(D-ND)

26. Law Enforcement
The Mortgage-related Crimes 50% Up
• The
Th number of FBI agents assigned t mortgage-related crimes i
b f t i d to t l t d i increasedd
by 50% between 2007 and 2008. In June 2008, the FBI stated that its
mortgage fraud caseload has doubled in the past three years to more than
1,400
1 400 pending cases Bet een 1 March and 18 J ne 2008 406 people
cases. Between June 2008,
were arrested for mortgage fraud in an FBI sting across the country.
• People arrested include buyers, sellers and others across the wide-ranging
mortgage industry. O 19 J
t i d t On June 2008 t
2008, two f
former B
Bear StStearns managers
were arrested by the FBI, and were the first Wall Street executives arrested
related to the subprime lending crisis. They were suspected of misleading
investors about the risky subprime mortgage market
market.
• On 23 September 2008, two government officials stated that the Federal
Bureau of Investigation was looking into the possibility of fraud by mortgage
financing companies F
fi i i Fannie Mae and F ddi M
i M d Freddie Mac, L h
Lehman B th
Brothers, and
d
insurer American International Group.

27. Litigation
Related to Subprime Crisis is Underway
• Litigation. A study released in February 2008 indicated that 278 civil lawsuits were
filed in federal courts during 2007 related to the subprime crisis.
• The study found that 43% of the cases were class actions brought by borrowers,
such as those that contended they were victims of discriminatory lending practices.
Other cases include securities lawsuits filed by investors, commercial contract
disputes, employment class actions, and bankruptcy-related cases.
• Defendants included mortgage bankers, brokers, lenders, appraisers, title companies,
home builders, servicers, issuers, underwriters, bond insurers, money managers,
, , , , , y g ,
public accounting firms, and company boards and officers
• Former Bear Stearns managers were named in civil lawsuits brought in 2007 by
investors, including Barclays Bank PLC, who claimed they had been misled. Barclays
claimed that Bear Stearns knew that certain assets in the Bear Stearns High-Grade
Structured Credit St t i E h
St t d C dit Strategies Enhanced L d Leverage M t F d were worth much l
Master Fund th h less
than their professed values.
• The suit claimed that Bear Stearns managers devised quot;a plan to make more money
for themselves and further to use the Enhanced Fund as a repository for risky, poor-
quality investments.quot; The lawsuit said Bear Stearns t ld B l
lit i t t quot; Th l it id B St told Barclays th t th enhanced
that the h d
fund was up almost 6% through June 2007 — when quot;in reality, the portfolio's asset
values were plummeting.”
• In 2006, the OFHEO announced a suit against Franklin Raines, former chairman and
chief executive officer of Fannie Mae which was eventually settled
Mae, settled.

28. Economic Crisis of 2008
• On February 22, 2008 Northern Rock was taken into state ownership
• Bear Stearns (takeover in March)
• Federal takeover of Fannie Mae and Freddie Mac
• Global financial crisis of September-October, 2008
– American International Group
– Merrill Lynch
y
– Lehman Brothers, Bankruptcy of Lehman Brothers (September)
– Washington Mutual, sold by FDIC to JPMorgan Chase
– Wachovia's banking assets were to be acquired by Citigroup[18], but then a
merger with Wells Fargo was announced[19]
– U.S. legislative proposals are made to provide economic rescue
– Hypo Real Estate (Germany, October)
– 2008 Icelandic financial crisis (Nationalization of Icelandic banks, October)
– October 9, 2008 - Dow Jones Industrial Average falls below 9000.

29. Looking Back The Past Economy
oo g ac e as co o y
1950s-1960s: A Period of Remarkable Stability
• As the 1960s drew to a close, the political leaders and
close
people living in the industrialized countries of the world
were eagerly anticipating the future.
• They were looking forward to a continuation of the rapid
economic growth and low inflation that characterized the
p
postwar era.
• When form 1950-1970 the industrialized countries
averaged an impressive annual real growth rate of 4.7
percent,
percent and the inflation grew at an average rate of only
3.7 percent.
• Jobs were plentiful and taxes were kept low. Politicians
were able t promise expanding public services, k
bl to i di bli i knowing
i
that a strong and growing economy would provide the
financing.

30. Looking Back The Past Economy
oo g ac e as co o y
1970s : The Utopia Came to an End
• The first evidence of 1970s the turmoil that was plague the global
economy throughout the decade appeared in the form of the
breakdown of the international financial system.
• On August 15 1871 President Richard Nixon hocked the world
15, 1871,
when he announced that he had directed Treasury Secretary John B.
Connally, “to suspend temporarily the convertibility of the dollar into
gold or other reserve assets except in amounts and conditions
determined t be i th i t
d t i d to b in the interest of monetary stability and in the b t
t f t t bilit d i th best
interests of the United States.”
• The bombshell abruptly ended the international monetary system
that had served the industrialized world for nearly thirty years
years.
During that time the United States had performed the role of Central
bank to the entire non-communist countries.
• The dollar was the standard international currency in trade and
financial circles, by standing ready to convert dollars into gold at a
fixed price of $35 per ounce—a price that had not varied since it was
first set by President Franklin Roosevelt in 1934.

31. Looking Back The Past Economy
oo g ac e as co o y
1974 : Never Before Had Suffered From Stagflation
• These events of currency instability were soon followed by an even
greater jolt to the global economy when, on October 17, 1973, the
organization of Petroleum Exporting Countries (OPEC) announced a
50-percent monthly reduction in oil export s to the United States and
p y p
other pro-Israel nations.
• It was quite a different matter in other parts of the world. The
quadrupling of oil prices by OPEC had launched a new era of higher
inflation d
i fl ti and great concern f energy conservation.
t for ti
• During 1974, real growth of the American economy declined
continuously. Unemployment increased from 4.6 % to 9% as an
additional 4 214 000 workers lost their jobs Nearly one third of
4,214,000 jobs. one-third
manufacturing plants capacity was standing idle, and inflation was
soaring, with consumer prices rising at an annual rate of 12.2%.
• The United States as not alone in suffering through the most serious
recession in postwar history. From 1974-1983 economic growth
rates among the industrialized countries averaged only 2.2 %.

32. 1981: Reaganomics
A Stage Was Set for A new Era of Economic Experimentation
• On February 18, 1981, President Ronald Reagan declared the details of his
18 1981
4-points economic program….
1.aimed at reducing the growth in Government spending and taxing,
2. reordering budget priorities,
3.reforming and eliminating regulations which are unnecessary and
unproductive, or counter-productive,
4.encouraging a consistent monetary policy aimed at maintaining the value
of the currency.
f th
• The proposal to reduce taxes by 10% every year for three years provided
the basis for what would become known as “supply-side economics, “ or
“Reaganomics,” It was far from conservative.
g ,
• Reaganomics is an identity based on a political philosophy of a greatly
limited role for government. And in developing this new identity, President
Reagan rolled the clock back to 1776 and Adam Smith, who championed
capitalism and laissez faire economics.
laissez-faire economics
• President Reagan in the United States, Prime Minister Margaret Thatcher in
Great Britain, and President Mitterrand of France intermingled their
economic policies with their political philosophies. They jointly opened the
door of supply side economic and a new economic era of th Gh t of
d f l id i d i f the Ghost f
Adam Smith, with less change till now 2000s.

33. 1990s and Greenspan
Derivatives is very useful tools?
• Greenspan's Folly --THE WORLD FROM
THE
WASHINGTON, Michael Hirsh, Sep 17, 2008
• The former Fed chief's culpability in Wall Street's woes.
p y
This mess is mostly a titanic failure of regulation. And the
largest share of blame goes back to one man: Alan
Greenspan(1987-2006)..
p ( )
• People mainly fault the former Fed chief, who once
enjoyed a near-saintly reputation because of his reputed
quot;feelquot; for market conditions, for ushering in an era of
feel conditions
easy credit that accelerated the mortgage mania.
• But the much bigger problem was Greenspan's Ayn
Randian
R di passion f regulatory minimalism. U d th
i for l t i i li Under the
Home Ownership and Equity Protection Act enacted by
Congress in 1994, the Fed was given the authority to
oversee mortgage loans.
t l

34. But Greenspan kept putting off
writing any rules
• As late as April 2005, when things were seriously beginning to go wrong he
2005 wrong,
was saying that subprime lending would work out for the common good—
without government interference. quot;Lenders are now able to quite efficiently
judge the risk posed by individual applicants,quot; he declared at the time. So
much
m ch for his feel Ne regs didn't get p t into place until this past J l
feel. New put ntil July—long
long
after the crash had come, under Greenspan's successor, Ben Bernanke.
The new Fed chief's quot;Regulation Zquot; finally created some common-sense
rules, such as forbidding loans without sufficient documentation to show if a
person h th ability t repay.
has the bilit to
• Greenspan has tried to defend himself repeatedly, though as bank after
bank has failed he's retreated to the shadows. But in a 2007 interview with
CBS he admitted: quot;While I was aware a lot of these practices were g g on,
p going ,
I had no notion of how significant they had become until very late.quot; This,
from a man who once told me, in an interview, that he most enjoyed
scanning economic reports for hours in his bathtub. Now, with Tuesday's
$85 billion bailout of AIG adding to the hundreds of billions the government
has already put up to rescue Bear Stearns, Fannie Mae and Freddie Mac,
this apostle of free-market absolutism has realized his worst nightmare. He
has given us the largest government intervention into the markets since
FDR.
FDR Heckuva job, Greenie
job Greenie.

35. Will Adam Smith Lose Favor?
da S ose a o
Invisible hand could be a hot favor
• Invisible Hand: The market economy would automatically adjust to bring about full
employment.
• The laws of supply and demand in a free market economy would operate to provide
jobs for all of those who wanted work. If demand for labor exceeded the supply,
wages would rise to equate the two.
two
• Attempting to drive the unemployment below the natural rate by increasing the
government spending or expanding the money supply, the results will be more
inflation.( Professor Milton Friedman of Chicago university)
• Government emphasis on stimulating consumer spending and particularly the high
spending—and
tax rate on investment income and the growth of social security—was greatly sapping
the incentives of Americans to save and to invest. (Professor Martin Feldstein of
Harvard university)
• The efforts by government to stabilize the economy or increase economic activity
would be completely ineffective.
• In a free-enterprise, private-property system, a corporate executive is an employee of
the owners of the business. He has direct responsibility to his employers. That
responsibility is to conduct the business in accordance with their desires, which
generally will be to make as much money as possible while confirming to the basic
rules of the society, both those embodied in law and those embodied in ethic custom.
(Milton Friedman 1970)

36. Will Keynes Return?
Demand Side of the Economy
• Th conditions of th 1930 gave rise t th K
The diti f the 1930s i to the Keynesian
i
Revolution. The conditions of the 1970s are different,
and it gave chance to the p
g policies of Adam Smith…
• 2000s seems running to a quite turning point, will it give
rise to the Keynesians?
• The Keynesian solutions:
1.Taxes will have been reduced,
2.government spending i
2 di increased, d
3.and the money supply loosened.
The d
Th demand side economy will h
d id ill have b
been stimulated t
ti l t d to
return to full employment.

37. Nobel Laureate:
How to Get Out of the Financial Crisis
By JOSEPH STIGLITZ Friday, Oct. 17, 2008, Times
• Capitalism may be the best economic system that man has come up
with, but no one ever said it would create stability. In fact, over the
past 30 years, market economies have faced more than 100 crises.
• That is why I and many other economists believe that government
regulation and oversight are an essential part of a functioning
market economy.
• Without them, there will continue to be frequent severe economic
, q
crises in different parts of the world. The market on its own is not
enough. Government must play a role.
Nobel laureate Stiglitz is University Professor at Columbia University.
He was chief economist of the World Bank and chairman of
President Clinton's Council of Economic Advisers

38. A Global Crisis
• What made America's recklessness truly dangerous is that we exported it A
America s it.
few months ago, some talked about decoupling — that Europe would carry
on even as the U.S. suffered a downturn. I always thought that decoupling
was a myth, and events have proven that right.
• Thanks to globalization, Wall Street was able to sell off its toxic mortgages
around the world. It appears that about half the toxic mortgages were
exported. Had they not been, the U.S. would be in even worse shape.
Moreover, even as our economy went into a slowdown, exports kept the
, y , p p
U.S. going. But the weaknesses in America weakened the dollar and made
it more difficult for Europe to sell its goods abroad. Weak exports meant a
weak economy, and so the U.S. exported our downturn just as earlier we
had exported our toxic mortgages.
p g g
• But now the problems are ricocheting back. The bad mortgages are
contributing to forcing many European banks into bankruptcy. And as
market participants realized that the fire had spread from America to Europe,
there was panic. Part of the concern is psychological But part of it is
panic psychological.
because our financial and economic systems are closely intertwined. Banks
all over the world lend and borrow from each other; they buy and sell
complicated financial instruments — which is why bad regulatory practices
in one country leading to bad loans can infect the global system
country, loans, system.

39. How We Got Here
• The troubles we now face were caused largely by the combination of deregulation
g y y g
and low interest rates. After the collapse of the tech bubble, the economy needed a
stimulus. But the Bush tax cuts didn't provide much stimulus to the economy. This put
the burden of keeping the economy going on the Fed, and it responded by flooding
the economy with liquidity. Under normal circumstances, it's fine to have money
sloshing around in the system since that helps the economy grow But the economy
system, grow.
had already overinvested, and so the extra money wasn't put to productive use. Low
interest rates and easy access to funds encouraged reckless lending, the infamous
interest-only, no-down-payment, no-documentation (quot;liarquot;) subprime mortgages. It
was clear that if the bubble got deflated even a little, many mortgages would end up
under water — with the price less than the value of the mortgage. That has
happened — 12 million so far, and more every hour. Not only are the poor losing their
homes, but they are also losing their life savings.
• The climate of deregulation that dominated the Bush-Greenspan y
g p years helped the
p
spread of a new banking model. At its core was securitization: mortgage brokers
originated mortgages that they sold on to others. Borrowers were told not to worry
about paying the ever mounting debt, because house prices would keep rising and
they could refinance, taking out some of the capital gains to buy a car or pay for a
vacation.
vacation Of course this violated the first law of economics — that there is no such
course,
thing as a free lunch. The assumption that house prices could continue to go up at a
rapid pace looked particularly absurd in an economy in which most Americans were
seeing their real incomes declining.

40. Their allies in investment banking bought them,
sliced and diced the risk and then passed them
on — or at least as much as they could.
• Th mortgage brokers l
The t b k loved th
d these new products
d t
because they ensured an endless stream of fees. They
maximized their profits by originating as many
p y g g y
mortgages as possible, with frequent refinancing.
• Our bankers forgot that their job was to prudently
manage risk and allocate capital. Th b
i k d ll t it l They became gambling
bli
casinos — gambling with other people's money, knowing
that the taxpayer would s ep in if the losses were too
a e a paye ou d step e osses e e oo
great.
• They misallocated capital, with massive amounts going
into housing th t was ultimately unaffordable. L
i t h i that lti t l ff d bl Loose
money and light regulation were a toxic mixture. It
exploded.

41. Discussion Questions
Groups Final Report
• Subprime Mortgage Crisis could be said as one of the most greedy business actions
done by a series of financial organizations and their high-ranking managements in
business history.
• After reading this stories, what does it mean to you in your ethical viewpoints?
Could you identify the core unethical issues ? And explain why unethical on
which theory or concept?
• Derivatives is not a single deal, should be done by a group of managements
among a group of organizations. What’s wrong of the corporate leadership and
culture? And how could be put to right?
• Please find out Lehman Brothers having independent directors or not? What’s
your opinions about the function of independent directors in ethical
management? And what’s your comments on the role of board of directors in
Lehman Brothers?
• Your group’s other findings /way of solutions, and what’s you learn in this
lecture.
• You are requested to join a group discussion ( the discussion record should be
combined with each one’s opinion and signature of joining meeting) , jointly write one
one s
group report better not over 9 pages (power point), and mail to professor Huang and
Doctor Chin not late than January 19, 2009.