By Aaron Unterman
istory will view the period leading up to today’s financial crisis as a period of unjustifiable excess. A period in which greed overtook reality and the developed world suspended disbelief in order to indulge in unprecedented and unsustainable levels of consumption. The financial crisis, which has been described as a perfectstorm, insinuating the intersection of random magnifying events, is actually the unwinding of the largest asset bubble and financial industry expansion in history. The financial crisis was preceded by an era of unparalleled growth and prosperity in the developed world. However, this period of unbridled optimism has come crashing to a halt, and it is clear that the global economy is in the midst ofa severe readjustment that will change the face of commerce. As we shall see, this economic bubble was the result of disequilibrium that attached inflated value to assets, instruments, and individuals and diverted financial resources to less productive uses of capital. The bloated financial industry, credited with ensuring the most efficient allocations of capital, has failed and drastically newapproaches are necessary to rein in an industry overwhelmed by greed. Much of the greatly lauded financial innovation that drove markets leading up to the crisis has turned out to be little more than mechanisms to avoid regulation and accumulate risk. According to Nobel Laureate economist Joseph Stiglitz: The fact of the matter is that most of our financial market’s creativity was directed tocircumventing regulations through creative accounting so that
no one, not even the banks, knew their financial position, and tax arbitrage.1 Evidence of the collapse of the financial system is abundant, and this author has dealt with the progression of the downfall in previous works.2 The investment banking industry, once the proud symbol of America’s economic prowess, has ceased to exist and mostof the nation’s largest and systemically important financial institutions are no longer viable without government support. The contagion from the financial market failure to the real economy has been devastating, and in what can only be described as a true injustice, taxpayers are being forced to devote billions to the bailout of the same institutions that caused the crisis. Allowing majorinstitutions to profit from irresponsible financial dealings and then intervening only when the consequences of their actions are manifest bails out those responsible for this financial disaster, inevitably with taxpayer money, and has the effect of privatizing profit and socializing loss. Most unfortunate is the fact that many people who will feel the brunt of economic pressures had nothing to do withthe greedy behavior that was its impetus, did not share in the benefits, and were largely unaware of the ongoings. The tragically unfortunate irony is that the honest working class citizen struggling to keep his home may have his tax dollars paid out in bonuses to those responsible for the crisis. The common theme that ties the financial crisis (and this article) together is one of misguidedincentives that pervaded the finance industry and perverted the actions of individuals and institutions resulting in a global crisis with severely deleterious social effects. In the world of finance, the greatest way to achieve a dramatic increase in wealth is to take large risks, of course, this is also the easiest way to lose it. A great deal of the so-called financial innovation that we experiencedpreceding the crisis was devoted to finding ways to take on as much risk as possible. In the financial world, risk-taking is known by the more innocuous term “leverage.” Generally speaking, regulators of financial institutions usually focus on reducing the leverage institutions incur. This is done
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Aaron Unterman is an associate in the financial...