Running head: CAUSE OF ECONOMIC CONDITIONS IN THE UNITED STATES AND THE UNETHICAL BUSINESS THAT LED TO IT

Final Paper
James Smith
Hodges University
GEB/PAD 6376
Dr. Forrer
Week Due: 14
Due: 08/14/2011
Submitted: 08/10/2011

INTRODUCTION (Part 1) Why has the unemployment rate been above 12 percent for the last several years? Why have so many prior successful businesses closed in the last four years? Why have so many major corporations and publicly traded companies filed for bankruptcy? Why did a house that used to cost $200,000.00 just sell for $40,000.00? Why are foreclosures at the highest rate in US history? Maybe the question to ask is what has caused all of this? There are so many questions to be answered when it comes to the economic conditions in the United States. How did it get into the current condition? What were the signs of slipping into the crisis (economic indicators)? Whose actions were responsible? Was the responsible party also guilty of unethical behavior (big issue) or was it accidental. How long will it take for the economy to get back to being productive? In the past, America has been a very productive, successful country. There have been other recessions and a depression that have affected the U.S. but for some reason this current crisis was started by a completely different chain of events. What was the chain of events that triggered this current catastrophe? There are so many questions that need to be answered for the people of America and this student is now on a mission to give the United States and the world an explanation about the crisis and possible solutions to getting out of the crises. After this catastrophe started in the United States, the rest of the countries in the world suffered the same fate. This is because the United States is a world economic leader and most other country’s successes and failures are dependent upon decisions made in the U.S. economic realm. This paper will explain all of the questions asked previously, look at economic trends and provide input of how to get back to a growing economy. Lastly, it will also explain how America slipped into the current crisis as it pertains to business ethics. If America knew the reason why the economy is in the condition it is currently in, there would be a lot more attention concerning this subject. The problem is that most Americans are uninformed about the true meaning of why current economic conditions are so bad. This research will be an eye opener concerning the current crisis and the business ethics (or lack of) that surround it.

LITERATURE REVIEW AND VARIABLES (Part 2) There is a lot of past study on the issue of current economic collapse in the United States (2007 to 2011). America started to see the signs of what was to become a recession in late 2007. According to Michael Clements (2011), these signs were decrease in tax revenue, decrease in building permits (commercial and residential), increase in unemployment, and a decrease in property value (p.208). To better understand and find truth behind what has happened from an economic stand point, it is best to investigate prior research and then build theories on what has already been looked at and/or eliminated. The following theories are possible causes of the economic meltdown that have already been looked at by prior researchers. Some researchers blame only one of the variables listed below while other researchers blame a combination of several on the list. This researcher has his own thoughts on the cause of the recession which is stated under the housing default cause but the root of the problem will not be revealed until the part three of the paper.

OIL PRODUCTION CAUSES As stated previously, it is important in research to know what has already been discovered by prior researchers just as it is important to know what has been discovered when each individual’s research has been completed. According to James Hamilton (2005), oil shocks were one of the possible causes in the last recession that started in 2007(p.1). It is interesting to learn about the causes and effects of fluctuating oil prices in 2007 and 2008 and how it triggered oil price shocks. These shocks were primarily caused by actual disruptions of physical oil supply. This caused oil supply to fluctuate and increase in a radical way which led to a strong demand in a stagnating world production. The causes of the shocks, in this recession were different from the causes of oil shocks in the last recession but the affects were the same. The affects of it were a recessed economy and stagnation. All though not all recessions in the United States have had oil production as a contributor, this recession did appear to be effected in a small way by oil productions. James Hamilton seems to think that this was a major contributor and the main cause for the last recession. This student can see the authors point in the article but the big picture shows that the oil had little to do with the latest economic meltdown. It could be part of what led to the recession but if it was, it was a very small part. It is good that economists looked at other causes in the recession besides the obvious causes like banks and housing default. It does produce a larger picture of other contributing factors that totaled the recession. As stated previously, oil did not play a part in every recession but every recession had a catalyst which formed a recession.

2007 RECESSION-VS-GREAT DEPRESSION OF 1929 The last recession has been compared to the crash of 1929 by economists. The reason is that this last recession had a greater impact on the U.S. and world economy than any other recession since the great depression. Were any of the causes of the last recession and “Crash of 1929” the same? According to Robert Hall (2011), there is little that can be learned from the Great Depression that should have stopped the last recession (p.431). In other words the depression era had a very low interest rate with low inflation which means that the nominal interest rate would be closer to zero. This caused the real interest rate to reach high levels. In the last recession of 2007 the low inflation resulted in an only slightly negative real rate when employment called for a low real rate because of declines in demand. It would seem that the causes of the “Great Depression” and the last recession were completely different. The people in the depression era were conservative in spending habits. According to Bill Streeter (2011), the difference in the people from the depression and the people from the 2007 recession is day and night when it comes to spending habits (p.12). Lending practices were also a lot more controlled and conservative back then. Could this be one of the causes of the 2007 recession? There will be more to come on this subject later.

UNEMPLOYMENT CAUSES Could unemployment be the cause of the current economic crisis or could unemployment the affect of the crises? According to Palgrave (2009), recessions always see a fall in gross domestic product (GDP) and are always characterized by rising unemployment (p.3). This researcher shows unemployment as an effect of a recession and never the cause for it. GDP is the total of goods and services produced in the United States over the period of a year. So not only is unemployment an effect of a recession but the decrease in goods and serviced produced also goes hand in hand with unemployment which makes perfect sense. The less goods and services being produced the less people are needed to produce a good or perform a service.

HOUSING MARKET AND DEFAULT CAUSES The most common cause of blame for the 2007 recession is the housing market. What happened that caused such a terrible recession. According to Bruce Yandle (2010), there has never been a mass default on real estate in the United States like the mass default that started in 2007 and is still going on (p.341). The banks would sell houses and the people who bought them would later realize that the payments were not able to be met and the house would eventually go back to the bank. It is one thing if this happens very rarely but when this becomes the normal transaction of a bank there is money being lent out and not any money coming back in. From a finance point of view there would be zero statement of cash flows and this is the beginning of a great recession. A bank makes money on interest off of loans but when the customer’s principle payments are not even being made then the banks start to have great difficulty. This raises interest rates and also makes it almost impossible for almost everybody to get a loan from the bank. The bank then sits in a stagnation state and consumer’s business’s and home buyer’s stop borrowing money. Since there is no money to borrow, houses stop being built, commercial building’s stop being built, roads stop getting repaired, small businesses stop growing, and lastly people get paranoid and stop spending money. It is a chain reaction process that has now led to a full blown recession after 2 consecutive periods. This is what has been researched so far into the 2007 recession. The question that is not being asked is what caused such a high default rate in real estate? When this question has been researched and answered then the root cause of the current recession will be answered. This student will research and attempt to find the answer to this in this research.

THE ISSUE (Part 3) The main issue being researched is why America went through such a terrible recession, why America is still recovering from a catastrophic financial crisis and how these events pertain to business ethics and corporate social responsibility. “Business ethics” deals with management making the right decisions within a company or organization to benefit stakeholders (stakeholder model) and operating from a legal (above board) standpoint. According to Aditya Jain (2011), corporate social responsibility is a comprehensive concept that deals with the promotion of responsible business practices closely linked to the strategy of enterprises (p.619). As stated earlier, prior research shows that the total current financial crisis started with the high default rate in the housing loan market. This is the place to start but what is behind this curtain? The high lending default is the plant but every plant has a root. What is the root problem which caused such a high default rate in the lending market? While digging and getting to the root problem the first issue that should be observed is “no proof of income”. According to James Garrett (2011), most of the mortgage loans issued between 2001 and 2006 were subprime mortgages and were given to unqualified borrowers that did not have the means to pay the loans back (p.1). Why would any bank want to issue a loan to a customer that did not have the means to pay the loan back to the bank? The answer is actually very simple but before it can be answered, a couple of other facts should be known. Prior to this era of subprime mortgages, the democratic side of the U.S. government created new legislation that gave permission for the banks to ease lending practices and make easy for everybody to own a house. After new legislation passed, this gave the green light for the banks to make trillions of dollars but not in an ethical way. Almost everybody who came to the bank for a loan was automatically approved (qualified or not). Again, why would a bank do this? The answer is because the bank that issued the loan would not be responsible for the loan in the case that the loan defaulted. As soon as the high risk loan was made to the customer, the bank would take the loan and sell it to a bigger bank or investment firm. These high risk subprime loans were referred to as credit default swaps. The same loans were sold anywhere from 30 to 60 different times to different banks. This turned 3 trillion dollars worth of debt into 60 trillion dollars worth of debt because each time these swaps were sold there was nothing backing the loan. This banking practice went on in most small banks between 2001 and 2006. Economists and financial analysts starting seeing the signs of a recession in late 2006 and by this time the large lending banks in America had around 60 trillion dollars in bad loans. According to Eric Reguly (2011), this 60 trillion in debt was the major contributor to the last recession and current economic condition in America (p.1). There were two democratic politicians that were in charge of the banking committees. Chris Dodd and Barney Frank were the two politicians in charge. These two men were warned several times by auditors and other politicians that bank fraud was being committed in the main lending banks (Fannie Mae and Freddie Mac) through the new relaxed lending practices. Both of these men ignored the warnings. The probable reason for these 2 men not changing lending legislation or launching an investigation into the matter was likely due to the fact these men were being paid very well to leave the situation alone and it is likely that these men already knew what was going on. Currently, neither politician has ever charged with a crime for letting this fraud continue. Eventually, new legislation was put into place to stop the relaxed lending practices. The banks were now overly consumed with bad debt so the U.S. Government decided to bail out the banks. The government then provided billions of dollars to the banks so the economy would not go into a collapse. The government should have put stipulations on the money (i.e. - a certain % would have to be used for loans every year). The opposite happened. Banks held onto the money and would not lend it out to private individuals or businesses. Since almost zero loans were being made, business growth ceased to exist, building stopped (residential and commercial), and the entire economic system followed suite and recessed. Getting to the point, America’s recession and current economic condition was caused by a few selfish bankers, businessmen, and politicians who turned these lending institutions into their own personal piggy banks and didn’t care about the larger picture (America’s economy).

Conclusion (Final Thoughts and Solution) (Part 4) Unethical business practice can have so many affects at so many levels. It can give a small business a bad reputation, put a large corporation out of business, land unethically minded people in jail or prison and even bring an entire nation and world economy to its knees. It is plain to see that the banks (that were selling these high risk credit default swaps) were not acting ethically. This whole concept started with a few shady businessmen and a few greedy politicians who were trying to get rich quickly. The practice of selling these swaps continued for too long (due to changed legislation) and started a recession before the average American could see what was going on. It finally led to a world-wide recession. America is still recovering from this and it is only improving a small amount at a time. Looking at past recessions, it took an equal amount of time to get into a recession as it took to get out of a recession (not including economic downturns with major variables like World War II). It was approximately three and a half years into the current recession until any real turnaround began. Because history usually repeats itself, it is this student’s opinion that it will be a total of around 7 years from beginning to end. Time, proper (ethical) steps, and letting the economy balance back out are the only long term remedies for America to get back to a normal economy. For example, banks are slowly starting to see a more balanced economic state and slowly starting to lend money. This means that businesses will start to open and hopefully unemployment rates will start to decline. It will continue to be a long time before all of the defaults have completed the foreclosure process and are resold. In order for the banks to speed up the recovery phase, the houses will have to be sold at highly discounted rates (creating quick sales). This creates an extremely large revenue loss to the banks but selling these vacant houses at a lesser price and then creating new loans including harsher lending practices is the first step in the recovery process for the U.S. banking. This practice in banking will also help the economy out of the current slump because money is once again being circulated which means the economy will once again experience production. In fact, according to David Dejong (2000), total factor productivity shocks are responsible for both starting and ending recessions (p.311). The banks selling the defaults and more money being available in lending are a few necessary steps that must be taken in order for productivity shocks to begin. This should eventually bring an end to the recession. The point of this research had 2 parts, the first was to see how America got into the recession and how it will be able to get out of it, the second was to see how business ethics are tied to the current chain of events. Getting into it was caused by unethical behavior in business but getting out of it will require time and ethical lending and business practices to be followed. Unethical business landed America and the rest of world into a recession/economic downturn and the only remedy is time and the reversal of the original problem which would be ethical business practices. It is plain to see the importance of ethical behavior and the major impact of unethical behavior in business. References
- Hamilton, J. (2009). Brookings papers on economic activity. Oil shock of 2007/2008. Washington: Spring 2009 Volume 210, Issue1; p. 215. Retrieved June, 2011, from the Proquest database
- Hall, R. (2011). The American economic review. The Long Slump. Nashville: April 2011. Volume 101, Issue 2; pg. 431. Retrieved June, 2011, from the Proquest database
- Streeke, B. (2011).ABA Banking Journal. American Banking Association. New York: 2010. Volume 103, Issue 1; Page 12. Retrieved June, 2011, from the Proquest database
- Palgrove, K. (2009). Economic and labor market review. GDP and unemployment: recessions compared. Basingstoke: November 2009. Volume 3, Issue 11; p. 3. Retrieved June, 2011, from the Proquest database
- Yandle, B. (2010). The independent review. Oakland: Winter 2010. Volume 14, Issue 3; p. 341. Retrieved March, 2011, from the Proquest database
- Garrett, J. (2011). About. Causes of Economic Recession. Retrieved July, 2011, from: http://www.comparativepoliticseconomics.com/causesofeconomicrecession.html
- Reguly, E. (2011). About. The Silver Bear Café (Truth shall set you free). Retrieved July, 2011, from: http://www.silverbearcafe.com/private/5.08/enigma.html
- Dejong, D (2000). The Journal of Applied Econometrics. Keynesian impulses versus Solow residuals. Chichester: May/June 2000. Volume 15, Issue 3; Page 311. Retrieved July, 2011, from the proquest database

- Jain, A. (2011). The Journal of Business Ethics. Corporate Social Responsibility and Psychosocial Management in Europe. Dordrecht: July 2011. Volume 101, Issue 4; Page 619. Retrieved July, 2011, from the proquest database

- Clements, M. (2011). Internal Journal of Forecasting. Combining Probability Forecasts. Amsterdam: April-June 2011. Volume 27, Issue 2; Page 208. Retrieved July, 2011, from the proquest database