Background of the Crisis
The financial crisis of 2008 was described by economists, analysts and even sociologists as the worst and most devastating economic crisis since the Great Depression. It threatened a total collapse of huge financial institutions, banks’ bailout by the governments, and major downturns in securities exchange around the world. Every sector of the economy in many countries of the world suffered a lot. Many people lost their jobs, and as a result, there was a prolonged unemployment, leading to the family crises and debts. The key businesses, including banks, failed, and there was a huge decline in the consumers’ profits. The smaller unsecured financial institutions suffered the worst ever insolvency, resulting from the bank runs that characterized the following period. The declines in consumers’ wealth were estimated in trillions of U.S. dollars. All these activities took a very short active phase, manifested as a liquidity crisis. It started on August 9, 2007 when BNP Paribas business with three hedge funds complained of “complete evaporation of liquidity.”
The Wall Street financial crisis was a hard blow to the global economy. The events leading to such a huge downturn only unfolded later. In September 2008, many Americans were faced with an extraordinary turn of events in the Wall Street financial markets and federal government response to these events. However, the problems had begun earlier, with the collapse of Lehman Brothers, the AIG bailout, Fannie Mae and Freddie Mac responsibility, and a possible stock market meltdown trapped their attention. America was frightened by the threat of a financial meltdown. Was the crisis unavoidable? The investigation commission shifted blame onto various players.
The Federal Reserve and other regulators were found responsible for the financial crisis. They were blamed for paving way for uncontrolled mortgage lending, excessive packaging and sale of loans to investors, and risky bets on the securities backed by the loans. According to the conclusions stated in the federal report on the crisis, the disaster was unavoidable because it was perpetrated by various regulatory failures of the government and corporate mismanagement, which was characterized by huge risks taking.
According to this report, the crisis did not begin with the 2008 financial markets meltdown. It started with the great metamorphoses of the global economy and the financial structure that comprised several stages unfolding for more than three decades. The 2008 stock market downturn was, therefore, the outcome of a long process of economic deregulation and unregulated macroeconomic reforms, mainly effected by the previous regimes. The coincidence of the crash aligning itself to a change of the regime was not planned, but it offered the new Obama’s administration a challenge to solve and rescue the economy.
By the end of August 2008, many financial institutions had been indicating huge losses, some so historical that there was the feeling of a looming danger of a crisis. Billions of dollars in losses were reported in the end month audits, increasing the pessimism among the investors and the regulators. On Friday, September 12, Lehman Brothers suffered a great collapse in the weekend negotiations indoors meeting in Wall Street. September 15 was a black Monday because Lehman Brothers filed for chapter 11 bankruptcy, Dow Jones experienced a historical average declined of 504 points (4.4%). It was the largest decline since the 9/11 attacks. On Tuesday, it was the turn of AIG, the insurance kingpin.
On September 16, the government reportedly granted AIG an $85 billion loan in exchange for a 79.9% equity share control. By September 29, Dow Jones had suffered a further 778 points decline in a single day, the highest ever in the stock exchange. The government wanted to provide a bailout, but the House of Representatives rejected the plan.
It should be noted that the influence of the crises on the social system can be discussed from the perspective of social inequality, industrial relations, labor systems disruption, and unemployment crisis. The aim of the following study is to show how the events unfolded to become a crisis that none of the workers and business persons in Wall Street could see it coming.
Sociological Point of View on the Crisis
It is important to look at an economic crisis from a sociologic perspective in order to understand its influence on the lives of people. The analysis conducted in this study will allow theoretically uncovering the incidences and reasons that led to the crisis and explain why it was so unpredictable. It is evident that there is a high connection between the historical occurrence of the financial crisis and the explanation of three main sociological theories. The main theoretical viewpoints are functionalism, conflict, and symbolic interactionism. From a functionalist perspective, those who are most talented in any field tend to work the hardest and will always succeed, whereas the less talented and lazy will fail. The economic downturns eliminate the poor operators while the advanced and better structured could survive.
The economy is a survival for the fittest. When a financial institution is seemingly operating within the expected standards, there are fewer worries about the downturn. However, in 2008, almost all financial institutions, specifically the most seemingly stable ones, were severely hit. This, therefore, means there had been a long spell of pretense of stability before many companies admitted the existence of the crisis.
From a conflict theory perspective concerning the issue, a capitalist system has a complex structure. Even those who are perceived to be in control of the systems and loans do not know how the system that they control works or how failure occurs in the system. Therefore, there are different internal conflicts among the big players, thus leading to a slow but eventual collapse of the system. It is, therefore, likely that for many years, the Wall Street looming conflict was only known to the insiders and not necessarily to the workers. What made the workers realize the existence of danger was the announcements of losses by many institutions at the end of August 2008. It was, however, too late; though, the companies tried to mask the danger with explanations. According to symbolic interactionism, when the workers realize the possibility of a downturn, their panic and actions to prevent it could lead to the real downturn .
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Historically, the events that preceded the Great Economic Depression earlier in the 20th century were deep socioeconomic inequalities caused by five important factors:
- The first factor is the triple rejection within the population of the Parliament, the Market, and Education. People stopped respecting their elected representatives and considered them political, greedy, corrupt, and self-serving. The market system was no longer taken to be self-sustaining and self-regulating. As a result, the public thought that the business was manipulated by the elites. Education was viewed as a symbol of the elite’s power and not an opportunity to create a system.
- The second factor is the rejection of intellectualism. The intellectuals were rejected because they failed to predict the crisis and could not mitigate the loss. The public considered them to have no useful skills and as parasites .
- The third factor is the successful application of the conspiracy theories. The theories have been appreciated by many people and always are used to place blame onto some form of power. The rise of propaganda and non-rational discussions concerning the pending crisis also result in inadequate concern being put on the real possibility that it could occur.
The following factors, if put together, allow explaining why the Wall Street crisis took place at a time when things were significantly changing. There were fewer people believing in conspiracy and non-rational discussion; in as much as this may appear a good development, it might have prevented the workers in the Wall Street from realizing the possibility of the crisis.
To them, provided the company they were working for seems stable, the rumors out of it do not count. This, in addition to the conflicts inside the particular companies that prevented any leak of information, blindfolded even the workers .
The Investigative Report of the Senate
The investigative committee presented a report to the United States Senate in April 2010, detailing the permanent findings. From the findings, it is evident that there were four critical causal factors that led to the economic collapse. These factors are high risk lending, regulatory failure, overstated credit ratings, and abuse of the investment banks. The report was organized in the form of case studies on specific companies in order to reveal each of these factors.
On high risk lending, the committee conducted a case study on Washington Mutual Bank. Before its collapse, the bank had been the sixth largest bank in the country, having over $300 billion worth of assets and more than $180 billion in deposits. The bank had 2,300 branches in 15 states. At the beginning of 2004, the bank was engaged in a loaning strategy to search for the higher profits by embarking on the high risk loans. After two years, the high risk loans began showing the high rates of delinquency. The mortgage-backed securities of the bank showed the downgrade ratings, as well as direct losses. It was revealed that the bank implemented the high risk loans and shoddy lending practices that provided millions of dollars in high risk and low quality mortgages. Those practices included permitting high risk borrowers for loans larger than they could afford to pay; moving creditors from normal mortgages to the new higher risk loan products; approving loan applications from borrowers without proper verification of their income; and providing loans with the low and short period rates. The bank also mismanaged the borrowings by failing to enforce the policies of compliance with own loan regulations. The rationale behind all this was to make it easier for the borrowers to seek the high risk mortgages and loans. The bank further designed differently compensation incentives for those who signed in order to obtain the high risk loans. The outcomes of these actions were that the bank went into losses of which only the industry insiders came to know.
The committee results indicated that the bank was involved in this high risk lending project because the high risk loans were regarded as having better backed securities and could go for a higher price in Wall Street. This is because a higher risk associated with them meant a higher coupon rate. Investors would, therefore, pay more for these loans than for the rated securities.
The bank did not restrict the unsecured lending. The following action led to its eventual downfall because the high risk lending became the source of the economic losses to the bank. However, to the workers in the bank and other institutions in Wall Street, there happened nothing abnormal. The uncertainties and the losses only remained as the secret information known only by management. It was, therefore, not predictable that these activities would lead to a crisis.
Regarding the second issue of failure in regulation, the committee examined the work of the regulatory body in Wall Street. The Office of Thrift Supervision (OTS) was scrutinized. The following body has a mandate to supervise and regulate all the types of lending and borrowing that take place in Wall Street. It was revealed that, in the period of five years before the crisis, the regulator had identified more than 500 cases related to the critical deficiencies involving Washington Mutual Bank . Most of these cases were related to the high risk borrowing and lending. The regulator, however, did not take any regulatory measures to ensure that the company did not proceed with the strategy. Although there were the documented reports showing that the bank had been reported on all cases and issues. It did not respond to the directives, and thus, the regulation body did not take any action.
If the regulatory body had taken action of either forcing the bank to stop the strategy or to put up strict procedures, the company would have relented in the implementation of the strategy. This would have saved the bank from the economic losses and crisis. The failure to make public the issue also indicates that, after all, only the top management involved in both cases were aware of the real situation. If the workers were unaware of what was going on, they could not predict a looming financial crisis. The secrets inside the financial institutions, therefore, resulted in the workers not knowing about what was happening until the crisis was inevitable.
The failure of the regulatory agency was related to its culture of having a less supervisory role and allowing the bank management to correct the highlighted problems without any interference whatsoever. The bank, therefore, took advantage of this minimal supervision to continue with its efforts to make more profit from the high risk loan strategies. Despite having identified more than 500 flaws in the strategy, the regulatory agency did not take any action that would have led to public concern and possibly prevent the crisis. Proper actions may have been hindered by the demoralized examiners, infighting within the agency, and reluctance in job performance.
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The third factor was that there were flaws in the credit raters’ side. Moody’s and Standards & Poor’s are the two companies mainly involved in credit rating in Wall Street. The committee, therefore, conducted a study on these companies and discovered the inflated credit ratings. The inflation masked the real risk involved in the forms of the business rated. Over the years, especially in the few years preceding the economic crisis, these two companies had been contracted by many companies and individuals. However, the mortgages that the companies rated as safe between the years 2004 and 2008 experienced delinquencies.
The possible reasons for this were found in the reports of the companies and through a market study. The credit rating business is highly competitive. Companies were likely, therefore, to hire a rater who was fast and could provide the admirable results. These were the results that the companies would feel comfortable to implement. In order to beat the competition, every company was required to give the ratings that would satisfy it. Thus, there was an overstatement of the safety of a number of the lending and mortgages. This is what ensued in the case of Washington Mutual Bank . The securities and mortgages were rated as safe; however, in the real sense they were not. The reasons behind this overstatement were poor prioritization. The raters put their individual interests before the safety of what they produce. The revenue they collected was more important to them than the safety of the ratings.
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Thus, it is evident that only raters knew about everything pretty well concerning the ratings. It was, therefore, not very easy for the workers in Wall Street to realize what was going on in these financial institutions. The evidence collected by the committee showed that the companies had been completely aware of the problems in the mortgage market and the high risk nature of the loans. However, instead of tampering their ratings following this information, they continued to issue highly risky grading of investments and credits.
This meant that when the loans and credits were highly rated, the risk associated with it was significantly masked, and as a result, the investor opted for these loans. The rating companies, therefore, was preferred by the banks if more investors liked their rates. It was, therefore, crucial that the company made the rates admirable. However, this happened at the expense of the financial stability of Wall Street.
The revenues of these companies became reliant on the commission that they got from the accepted ratings, and thus, this perpetuated the crime. They kept on changing the ratings only for their own profit without the slightest awareness of what they were doing to the investors and the banks. They also did not know what other players were doing. The occurrence of this was only known by the companies themselves, and this prevented mitigation actions until it was too late.
The fourth factor is the abuse of the investment banks. Essentially, the investment banks have a mandate to direct funds into the projects that are beneficial to the economy in that they are income generating and have various employment opportunities. The two major investment banks in Wall Street are Goldman Sachs and Deutsche Bank. The committee conducted the case studies on these two financial institutions and discovered that they had been misused to provide cover for the higher risk loans and mortgages . Their involvement was through the production and sale of cover policies for other financial institutions. This was undertaken under the statement that the loans were not high risk and that the ratings were genuine. What they did not understand was that other institutions had already manipulated the market individually to improve their profit. Therefore, what happened to the market was simply a collapse due to pressure from all sides .
The two investment banks, therefore, abused their mandate when they started selling the security plans on mortgages. They contributed not only to the delinquency intensification, but also the overall collapse of the financial sector in Wall Street. Like all the other factors above, the activities of the investment banks were masked to appear as their normal mandate. However, they did not also realize that other players in the business were also cunning.
The workers in Wall Street remained unaware of what was happening inside the financial institution until significant financial losses were announced by the latter. At this time, nothing could have been made to avoid the crisis.
It is apparent that the workers in Wall Street were not aware of the impending crisis because of the issues related to the secrecy of the players. The information running inside the companies was held rather confidential in a social stratification view. Only those who were regarded to be part of the plan knew about what was going on. The workforce was not involved in any issues and, therefore, did not see the crisis coming. The role of socialization also played a significant role. As far as the stakeholders were concerned, they were the only ones with a program to obtain profit from the situation. However, this is only a belief created by the fact that most of the players only had business relationships; otherwise, they were rivals. They, therefore, could not share the information that could have probably saved the situation. This means that lack of enough socialization in this setting resulted in the culmination of the crisis that nobody saw coming. The separation of a group of workers who were not involved is a concept of social classification. This resulted in misinformation and reduced preparedness of most of workers.
These reports and factors adequately identify the key concepts that led to the process of the crisis. The factors when observed separately indicate a single plan by an individual player in the Wall Street financial market. It is evident that every individual or company wants to get profits by using all possible means. As a result, there are usually no conformity and order in the company, society, and state. When these do not exist, a little part that each individual or company plays to achieve the best for himself/herself or itself at the expense of others could lead to one big crisis that affects all of them. Such a crisis is usually unpredictable and devastating in the long run. The main reasons why the workers in Wall Street did not see the crisis coming were that firstly, all the issues related to the whole problem were secretly kept by the key players, secondly, the lower class workers were not involved in it, and thirdly, there was no socialization in Wall Street.
The Wall Street economic crisis of 2008 is considered one of the largest and most felt economic crisis since the Great Depression. It happened at the time when all the players in the financial market were trying to make a profit. The issues related to this crisis remained a mystery for a long time. The investigative report was also faced with a number of challenges that threatened the implementation of the recommendations.
The fact that the workers in Wall Street did not predict the looming crisis or detect changes that could lead to the crisis is interesting. However, the report shows the secrecy with which each of the players in the crisis followed their own benefits. None of them would reveal their plans others, and therefore, each of them thought the fraud was only on their side.
As described in the investigative report, the process was so secretive with each of the players aiming at benefiting from their activities. The failures of every regulating body and financial institutions had secret motives for self-benefits.
In this study, the unpredictability of the crisis and the probable position of the workers in the whole process that took almost five indoor years before all the frauds and failures resulted to the crisis were examined and analyzed from a sociological point of view.