Ethics for Business and Accounting

Ethics for Business and Accounting

Assignment #1

1. How much and in which ways did unbridled self-interest contribute to the subprime lending crisis? 

Issues with self-interests contributed to the subprime lending crisis from many aspects, including homeowners, banks (or the lenders), investors, and rating agencies.

• Homeowners: the homeowners, especially the ones who were considered to be “ninja” (no income, no job, no assets), certainly recognized the possibility that they were unable to pay off their home mortgages and may go default when the mortgages went up because of higher interest rates. However, they still entered contracts with the banks and borrowed money from them just because these homeowners wanted new houses.
• Banks: the banks ignored that fact that many of the borrowers lacked the ability to pay off their mortgages by not checking the credit histories of these homeowners. These banks were only interested in making money from rising home prices and higher interest revenue.
• Investors: the investors were willing to take those subprime mortgages for their higher returns but did not fully assess the risks associated with them
• Rating agencies: The banks needed high-rating loans to sell to the investors; the investors didn’t want their investment to be downgraded. Therefore, the rating agencies made money from the banks and investors by giving high ratings to those subprime loans.

1. How could increased regulation improve the exercise of unbridled self-interest in decision making? 

The regulatory entities should enforce higher constraints and oversights to the market. For example, legislation could be written to set the highest level of leverage that enterprises are allowed to reach. Also, the government could impose more strict rules on background checks for securities borrowers so that it can help to maintain a healthy debt market environment. By having these thresholds, the regulators can help to prevent the underlying financial risks from the beginning before they turn into actual damages.  

1. How could ethical considerations improve unbridled self-interest in ethical decision making? 

By having ethical considerations, the decision makers will now consider the impact of their actions brought to all parties related rather than only considering the interests of themselves. In other words, decisions can be made to extend the interests of all stakeholders involved instead of benefiting the decision makers themselves at someone else’s expense.

1. Identify and explain five examples where executives or directors faced moral hazards and did not deal with them ethically. 

• The executives/directors of the banks decided to sell those subprime loans to investors and did not properly tell the risks associated with them. (dishonesty / conflict of interests)
• The executives/directors of the rating agencies provided unmatched ratings to those subprime loans in order to make money from those greedy lenders and investors. (dishonesty / conflict of interests / incompetence)
• The executive/directors of the banks found the way of making money from rising home prices and high interest rates and decided to lend money to homeowners without conducting proper background checks. (conflict of interests / incompetence)
• The executive/directors of those banks and investment firms let their companies make huge money from those subprime loans to boost their financials in appearance so that they could earn bonuses. (greed / conflict of interests)
• Some of the executive/directors of those banks and investment retired with huge amount of compensation when the crisis occurred and did not take the responsibility of the bad decisions they had made. (conflict of interest / incompetence / lack of responsibility)

1. Given that the marketplace for securities is global, and that the risks involved can affect people worldwide, should there be a global regulatory regime to protect investors? If so, should it be based on the regulations of one country? 

The concept of having a global regulatory regime to protect investors is ideal. However, it is hard to achieve such goal in reality. Every country has its own unique culture, political environment, financial market and infrastructure. The current regulatory regime in each country is built upon these unique circumstances. It is very hard to set up an authority or come up with a set of rules that’s suitable for everyone. For example, the International Accounting Standard Board (IASB) has been working on spreading a global accounting standard, or IFRS, for decade. However, several big countries such as the U.S. and China are still using their own standards today because the uniform standard might not be the optimal solution for some of the issues brought by their unique political or economic conditions. What actually is happening today, on the other hand, is that the U.S. and China are working with the IASB on standard convergence, making the standards more similar to each other while still keeping some of the unique ones. This approach is what the securities market can learn from. In other words, countries can come together and discuss some universal rules that can be imposed on everyone and still have the opportunities to have their own different regulations within the countries that are designed to fit the different environments.