Activity Base CostingRobersonCase Study: Inside JobThe movie Inside Job was an interesting and thought provoking movie on the economic crisis of 2008. It did a great job of tying together the cause and effect of actions taken by those involved in the crisis. Over the next several paragraphs I will explain how the positive intentions of financial innovation and regulation often lead to less desirable unintended consequences. I will also explain how the financial crisis of 2008 occurred and who and where should the blame be placed.
In financial markets there will always be a desire to seek more and larger profit margins. Financial innovation that finds new ways to generate funding is the path to those profit margins and also funding to clients that might not otherwise be available. With great intentions there are often unintended consequences generated. Some unintended consequences pointed out in the movie were; lost of personal contact with local banker; local banks not taking responsibility for loans, the interconnections of financial markets (commercial banks, investment banks, insurance firms). The most critical consequence is the political influence financial institutions have over the government.
Another area in which unintended consequences impact financial markets is regulations. Inspection and oversight of any industry has its’ place, in fact history has proven that businesses without some form of regulation will find themselves making poor judgments leading to legal and potentially financial disaster. Too restrictive regulations lead to cumbersome guidelines slowing down funding applications. The regulations are not timely in a fast moving world market place and they tend to discourage potential investors. A major unintended consequence occurred when the Security Exchange Commission (SEC), gave big rating agencies a regulatory role. They defined risk which they were supposed to
The SEC is “doing its job. But it is not what is really doing the job” and may be working on its agenda. There are many aspects to oversight, the SEC is not the regulator that is supposed to “fix problems that may happen in the life of an industry.” It could make a critical difference if new rules or actions are required and if they don’t help investors. In theory, regulators should be the ones that bring into the market with their own rules. In practice the SEC, as long as it follows the rule, will not make those rules or actions.
Investors of any size, large or small, will be required to use good judgment and financial responsibility, but they will be charged a fine for using bad judgment. Such fine will be much lower than a fine for the company or its employees and may be subject to criminal prosecution. With the right rules and policies, the SEC and its employees will be well-protected and will not be subject to liability for bad money using their financial influence, including bad business practices. But the SEC must, at the core of any successful regulatory agency and by its very nature, is independent. It’s a public agency, but its mission and functions are public and regulated, and the role it functions requires it to ensure that its rules are followed. The role it should assume is to enforce the SEC’s regulatory and enforcement responsibility for the market it regulates, not give its discretion to how it handles a customer and its competitors, or how it handles financial dealings.
This article from November 27, 2009 summarizes some of the regulatory problems facing the U.S. Treasury Department in the early 20th century. In part:
The problems are particularly acute in the large banks, where the banks that have the biggest credit portfolios (which are at least 50 million) have a large financial system that depends on large, long-term exposures to risky, risk-averse financial markets.
Although the Treasury Department is not actually going to create a national financial regulator, there would be a major issue because the existing Financial Stability Oversight Council and CSA are in charge of regulatory and investment regulation in a large government capacity.
The CSA was instituted in the Federal Reserve System to “prevent reckless investment actions that result in long-term harm toward public credit and financial institutions.”
Because of the FSC’s involvement with credit markets, there has been a significant decline in the number of banks with sufficient capital to adequately manage the markets and the risks therein. The lack of liquidity is a growing problem, and is especially acute in the major commercial financial centers of the world.
In 1999, there was an all-too-common trend, of more and more big banks adopting risk management strategies, with the majority of these using “easy money” strategies like buying and selling securities in a bubble