It is common to argue that the financial crisis of 2007 – 2008 was the result of financial innovations like collateralized debt obligations (CDOs) and credit default swaps (CDSs), created by greedy bankers who did not understand their own creations (e.g. McDowell 2011). Do you agree or disagree with this analysis? Give reasons for your answer.
Greedy can be defined as having a strong desire to have more than you have already got. The bankers discussed in this piece, who were involved in the creation of products they knew little about, fit this definition perfectly. Collateralized debt obligations (CDOs) are an example of one of these products. They are bonds linked to loan packages that are sold to investors for a price that reflects their level of risk; and so are separated the originator of the debt from the bearer of the by-product. Parts of these CDOs are then supposedly insured by a complex financial instrument, known as a credit default swap (CDS), to free them from any risk they may have. However, due to their complexity, the bankers who produced them did not comprehend the extent at which the economy could be affected by their ‘risk free’ innovation, and so their lack of understanding and their blindness to everything other than their own assets, led to the creation of one of the root causes for the financial crisis. Through analysing and evaluating a variety of academic sources which explore the causes of the financial crisis of 2007-2008, I aim to prove my argument that I agree with the analysis posed in the title- that due to the greed and ignorance of bankers, their financial innovations were the main cause of the financial crisis. This essay will begin by discussing the viewpoints of Paul Mason on the awareness of bankers towards the products they were producing and selling, the reasons behind the creation of these products, and the impact that these financial innovations had upon the economy. It shall then examine the implications of Andrew W. Lo, Linda McDowell and Gary Gorton towards the features mentioned in the previous sentence.
To begin, this essay shall consider the viewpoints of Paul Mason in his book Meltdown: The End of the Age of Greed and his understanding of how knowledgeable bankers were about the financial innovations they created. The deregulation of the financial system on 11 November 1999 enabled investment banks to hold the public’s savings and to function as insurance companies (Mason, 2010). Through manipulating their new freedom, bankers came up with an idea to produce a loan package which could be perceived to hold little risk- a CDO. Rating agencies then assessed that risk and due to the complexity of the CDOs, they were declared risk free; thus making them more attractive to investors. Mason believes that the shaping of these financial innovations was driven by the greed of the bankers and their constant desire for more (Mason, 2010) which is in support of my argument addressed in the introduction. The fact that he discusses an idea of neo-liberal ideology to validate and legitimise greed strengthens his understanding of the financial crisis of 2007-2008. This ideology can be defined as a set of ideas that maintains that a group of people in power can have economic dominium held over them because the dominant have enough understanding for the group to concur with the dominium (Mason, 2010).
This essay will now consider the interpretations of Linda McDowell. McDowell indicates in her article that the purchasers of CDOs knew almost nothing about their structure or about the risk involved, but that the bankers who created them had every intention to find a method of placing collateralised debts off balance sheets (McDowell, 2011). This is in agreement with the ideals posed by Mason and my own argument and so can be seen to be a significant element in the downturn of subprime lending. In her exposé, the American multinational banking corporation -JP Morgan- is given the blame and...
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