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The global disaster known as the Great Recession of 2008 has been argued to be a direct result of subprime lending and the collapse of the CDO securities market, also known as collateralized debt obligations. Spurred by greed and lack of due diligence, it is also argued that repealing the Glass-Steagall Act may have loosened restrictions that allowed such behaviors. While trying to fix the aftermath of the housing bubble collapse desperately, the U.S. failed to raise rates in time and curb inflation, leading to bailouts and spending that affected millions.

Keywords: Great Recession, subprime lending, CDO - collateralized debt obligations, inflation, Glass-Steagall Act, regulatory compliance

Introduction

The assessment of the global disaster of the Great Recession of 2008 can be best described as a system of greed and perpetual ignorance of fiscal responsibility and regulations. In a nutshell, financial regulators such as the SEC, among other regulators, failed to act or chose to ignore the outcome of the continued and prevalent greed and manipulation of the housing market. This, in addition to legislative failure to act by Congress and the unchecked printing of U.S. currency, inflation, and continuous low interest rates, was a perfect disaster for the financial crisis seen in 2007-2008. Additionally, some scholars argue that the partial repeal of the Glass‐Steagall Act by the Gramm‐Leach‐Bliley Act directly aided in the lack of regulatory safety nets in the banking and investment industry, directly led to the housing market crash in 2008.

The Rise and Fall of Collateralized Debt Obligations

A CDO or collateralized debt obligation is a complex structured finance product that is backed by a pool of loans and other assets; these underlying assets serve as collateral if the loan goes into default; though risky and not for all investors, CDOs are a viable tool for shifting risk and freeing up capital (Tardi, 2021). In other words, CDOs are nothing more than playing cards at a casino. As they are more or less based on a gamble, the investor makes on assets backed by loans that will be paid back by borrowers over the time of the obligation. That said, early CDOs by assembling portfolios of junk bonds issued by different companies are called "collateralized" because the promised repayments of the underlying assets are the collateral that gives the CDOs their value; ultimately, other securities firms launched CDOs containing other assets that had more predictable income streams, such as automobile loans, student loans, credit card receivables, and aircraft leases (Tardi, 2021).

The conditions that created the precursor for the boom in trading of CDOs were due to low interest rates, benign credit conditions, and tight credit spreads that have pressured investment returns and challenged investors’ ability to meet yield objectives; this has led some investors to seek higher returns by taking more risk, particularly in derivatives-based investment products, which are often called synthetic credit products because the investor does not have direct exposure to the credit of the underlying borrower (The Rise of Collateral, 2020). In that, the continuation of the rise of real estate as a direct result of the continuation of the Federal Reserve's endless printing of U.S. currency, the continuation of unprecedented low-interest rates, and the stability of home ownership led to a spearhead of CDO investment on an ever-increasing rise in home purchasing and loan processing. However, at the same time, the government was pushing to get families, especially lower-income families to buy homes; this, combined with low interest rates in the 2000s, caused a rapid swelling of the housing market, with financial institutions and investors putting large amounts of money into the land; consumers borrowed freely from the value of the house, and continued to purchase, creating a bubble; eventually, like all bubbles, the housing market collapsed, causing all the investments to disappear (Moss III, 2018).

Following the collapse of the housing market, led by sub-prime lending as a direct result of CDO investments, the underlying issue is not so much a problem with subprime lending but the pushing and backing of CDO investment by investment banking and mortgage processing organizations like Freddie Mac, Fannie Mae, and Lehman Brothers (who became insolvent as a direct result of the housing crisis of 2008). This led to the Great Recession, followed by a major correction in the U.S. stock market.

Corruption, Greed, and Failure of Regulators to Act

Corruption and greed, most of the time, are a direct result of regulatory agencies acting or the lack of regulation altogether. Moss III (2008) explains that the Great Recession should not have been so great. Economies function in cycles: first, there’s a rise, then a fall; a fall in 1990 meant an increase throughout at least the rest of the decade before falling again; the reason the Great Recession occurred was through deregulation and new policies, America has consistently had economic problems whenever banks are permitted to invest in stocks and securities: the Great Depression, the recession in the 90s, and the Great Recession are all linked by a common factor (Moss III, 2018). The normalcy of a healthy economy is the growth and retraction of economic investments and viability. However, the creation of the CRA encouraged the creation of subprime mortgages; the promise of money for these mortgages and pooled securities from Fannie Mae and Freddie Mac encouraged banks to provide a glut of these mortgages (Moss III, 2018).

The CRA is short for the Community Reinvestment Act, enacted in 1977, and it requires the Federal Reserve and other federal banking regulators to encourage financial institutions to help meet the credit needs of the communities in which they do business, including low- and moderate-income (LMI) neighborhoods (Federal Reserve Board, n.d.). However, the CRA was believed and argued to be the primary reason for the housing market's collapse due to a high level of default among subprime lending and a deregulation of the market. However, some scholars may argue that predatory lending and a lack of due diligence by lenders should be considered as a more viable reason for the massive defaults, in addition to the rapid growth in CDO investment, as previously mentioned in the previous section on the rise and fall of collateralized debt obligations.

Theoretically and empirically, Pavlov and Wachter (2011) found that aggressive lending instruments magnify real estate market cycles. For example, markets with high concentrations of aggressive lending instruments are at risk of relatively larger price declines following a negative demand shock; at the same time, markets that decline the most following a negative demand shock tend to suffer greater withdrawal of aggressive lending; this magnifying effect on the downside is present even in the absence of sizeable default rates. (Pavlov & Wachter, 2011). Essentially a hyperinflated local housing market was a direct cause of aggressive lending by lenders who have the most to gain from the loan i.e. the packaging of junk CDOs that mixed in with both prime and subprime lending mortgages and sold to more established lenders like Freddie Mac or Fannie Mae or a large investment bank like JP Morgan as an investment instrument. It’s basically nothing more than a Jordan Belfort Wolf of Wall Street-style penny stock pump-and-dump trading scheme. But instead of an unknown shady stockbroker calling out of a Long Island boiler room selling worthless stock, it’s a lender selling a dream that eventually becomes a nightmare. Either way, it's wrong and immoral and hurts those who may not be able to recover from such a too-good-to-be-true once-of-a-lifetime poorly advised investment.

The Glass‐Steagall Act, Could This Have Been Prevented?

Scholars may argue that the partial repeal of the Glass-Steagall Act, also called the Banking Act of 1933, directly impacted the housing crisis and was the primary reason for the Great Recession of 2008. However, neither could be true, as the 2008 financial crisis had precious little to do with Glass‐Steagall, one way or the other; it was caused primarily by bad lending policies, which in turn led to
the growth of the subprime market to an extent that neither the lawmakers nor regulatory authorities recognized at the time; the commercial banks and parent holding companies that failed — or had to be sold to other viable financial institutions — did so because underwriting standards were abandoned. Yes, these banks acquired and held large amounts of mortgage‐backed securities, which pooled subprime and other poor-quality loans, but even under Glass‐Steagall, banks were allowed to buy and sell MBS because these were simply regarded as loans in a securitized form (McDonald, 2016). This is why regulation sometimes requires a cause to find issues or concerns before Congress can act in writing rules to prevent harm in future dealings. At the end of the day, government can’t be the primary go to in preventing a serious ethical or moral decay of a society as a whole. Sometimes, it takes self-regulation and integrity to gain trust in the community in which these organizations serve. During this period in lending, banks and those who represented mortgage back securities failed to act and or ignored and silenced any dissent in helping to prevent this fiasco from occurring at the level that it did at its peak in 2008.

Ethics in Economics, the Key to Success Through Ethical Leadership

The key to success in any undertaking is to maintain a stable and functional foundation in ethics and accountability. Greenleaf's interpretation of a servant leader, is a leadership style that focuses primarily on the growth and well-being of people and the communities to which they belong (What is Servant Ld., n.d.). Organizations that put the needs of stakeholders before their own are not only the cornerstone of servant leadership but a moral imperative. Coffee (2016) explains that most public companies do behave responsibly (at least most of the time); nor is it denied that boards should seek to maximize shareholder value over the long run, even if that implies losses for other stakeholders; rather, what is contended is that activist pressure tends to curb the board’s discretion to (1) plan for the long term; (2) disdain questionable or unethical behavior; and (3) accommodate the legitimate interests of other stakeholders (Coffee, 2016). All of these standards fall ideally within the realm of an organization being led by a servant leader. Coffee (2016) concludes that modern organizational leadership has moved, or is at least moving, from a board-centric system of corporate governance to a shareholder-centric system; this recognition has two major implications: (1) corporations may be less law-compliant and more risk-tolerant in this brave new world, and (2) stakeholders are increasingly exposed to loss from short-term activism (Coffee, 2016).

That said, and after considering the impact of the Great Recession of 2008, those affected by this tragedy affected the U.S. economy and the greater Global economy as a whole. It is clear that something was either seriously broken in the U.S. trade or that unknown actors did not conduct themselves in a manner that was in line with servant leadership qualities of putting stakeholders' needs before their own. More importantly, these same unknown actors failed to plan or consider the long-term repercussions of these CDO investments.

With that said, Gigol (2020) explains that business ethics are an important part of corporate sustainability, with authentic leaders who impact the work engagement and well-being of subordinates through sustainability concerns not only the environment but also the well-being of employees (Gigol, 2020). Leaders, especially servant leaders, help create an ethical work and sales culture by leading by example. Ko et al. (2018) further explain that when followers assess their leader, their perception of ethical leadership is influenced by the leader’s characteristics; if leaders do not pursue ethical values, this will quickly become transparent to employees, decreasing their confidence in the leader; and if leaders only pretend to care about ethical values but display unethical behaviors in practice, followers will perceive them as a hypocritical leader (Ko et al., 2018). It's important for leaders, especially leaders in banking, lending, and real estate, to admit when they are wrong. This did not occur at any time during the housing crisis or the Great Recession.

Conclusion

To conclude, the rise and fall of collateralized debt obligations created a culture of growth and fast money in the field of real estate. This, however, came at the cost of the U.S. economy and the greater global economy. CDOs were created as one of many financial tools that bankers use to bet on financial securities, like a gambler at a casino. There really isn’t any difference between the two. It comes down to greed and sometimes the failure of public and private leaders to act or, at the least, regulate themselves. Some scholars argue that regulations at the time, including the Glass-Steagall Act, which was partially repealed, even after the fact, may not have been enough to prevent the financial crisis from occurring in the first place. Sometimes, practicing self-regulation and finding moral and ethical standards is important, especially when dealing with other people's livelihoods. Regardless if Regulation exists, but it is still up to the leaders of public and private organizations to practice some level of autonomy through either servant leadership or some other type of system that prevents moral decay from occurring because of one rotten apple the bunch. The Great Recession caused serious repercussions for the United States and the rest of the world. References

Coffee, J. C. (2016). Preserving the Corporate Superego in a Time of Activism: An
Essay on Ethics and Economics. Available at SSRN 2839388.

Federal Reserve Board - Community Reinvestment Act (CRA). (n.d.). Board of
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Gigol, T. (2020). Influence of Authentic Leadership on Unethical Pro-organizational
behavior: the intermediate role of work engagement. Sustainability, 12(3),
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McDonald, O. (2016). The Repeal of the Glass-Steagall Act: Myth and Reality. Cato
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Moss III, R. A. (2018). How America Permitted the Great Recession.
Pavlov, A., & Wachter, S. (2011). Subprime lending and real estate prices. Real
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What is Servant Leadership? (n.d.). Greenleaf Center for Servant Leadership.
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https://www.greenleaf.org/what-is-servant-leadership/

Tardi, C. (2021, May 20). Collateralized Debt Obligation (CDO) Definition.
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The Rise of Collateralized Synthetic Obligations: Beware the Rhyme of History |
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