Estimation Techniques of the U S Financial Crisis

Estimation Techniques of Financial Crisis

The unquestionable ethical conducts within the corporate circle had been the major factor that led to 2008/2009 financial crisis. By studying the root causes of the crisis, it has been revealed that bad conducts among the CEOs of Bear Stearns, Lehman Brothers, Citigroup and Countrywide Financial have been the primary factors leading to 2008/2009 financial crisis.

Objective of this paper is to argue that the CEOs of Bear Stearns, Lehman Brothers, Citigroup and Countrywide Financial did not take the interest of the companies into a consideration leading to frictions between the CEO and the shareholders

In 2007, the financial markets were shaken by a serious financial crisis because of a dryness in liquidity associated with a subprime mortgage business where people with doubtful credit reports were offered mortgage loans leading to a rise of loan default. Moreover, lack of transparency, greediness and excessive desire for money have been the major factors that led to the financial crisis. (Gorton, 2008). The greediness was demonstrated among the CEOs of Bear Stearns, Lehman Brothers, Citigroup and Countrywide Financial where all of them increased their compensation packages without putting the companies' and shareholders' best interests into considerations. Traditionally, the Bear Stearns, Lehman Brothers, Citigroup and Countrywide Financial were publicly traded companies and raised largest percentages of their liquidity from shareholders' funds. Thus, their primary obligations are to protect the interests of the companies and shareholders. However, the CEOs of these companies did not respect these obligations rather they indulged in the risky businesses that consequently eroded the shareholders' wealth.

Between 2004 and 2007, Lehman Brother, Citigroup, Bear Stern and Countrywide Financial indulged in the high-risk subprime lending involving offering mortgage loans to people who did not qualify for the loans. The subprime lending is a type of loan where a financial institution offers loans to people who do not qualify for the loan or people having difficulties in repaying back the loans. However, Lehman Brothers, Bear Stearns, and other financial institutions immensely indulged in this type of financial practice because of greediness. Additionally, these loans were characterized with poor collateral, and high-interest rates to compensate for higher loan risks. Despite the higher risks associated with the subprime lending, the CEOs of these financial institutions invested largest percentages of the companies' financial assets in the business because of its associated high interests. For example, Lehman Brothers invested over $146 billion dollars in the subprime lending. Bear Stern also used approximately $13.40 trillion in the mortgaged-backed derivative financial instruments. All these companies recorded abnormal profits when between 2005 and 2007, however, the recorded profits were tied to the subprime hedge fund across the United States.

"These companies did so at the expense of millions of ordinary Americans and investors of all types -- including other financial institutions, universities and pension funds, cities and towns, and even hospitals and religious charities," Holder said at a news conference announcing the settlement." (Tucker, 2014 p 1).

Despite several warnings from financial experts about the associated risks of subprime lending, the CEOs of the companies were not pursuing the interest of the companies rather they went ahead to increase their compensations. An expert in stock trading had warned the Citigroup that "he would not be surprised if half of these loans went down it was amazing that some of these loans were closed at all." (Tucker, 2014 p 1). Despite this warning, the CEOs of the Citigroup and Countrywide Financial increased their compensations to $25 million and $43 million respectively. The CEO of Bear Sterns also increased his compensation package to $34 million in 2006. In the same year, CEO of Lehman Brothers increased his compensation to $27 million. (Larcker, & Brin, 2010). However, these executives did not compensate their companies with revenues increase despite an increase in their compensations. For example, Bear Stern filed for bankruptcy a year after an increase in CEOs compensation with the cost of $2.7 billion taxpayer money. Lehman Brothers also filed for bankruptcy revealing the largest bankruptcy ever recorded in American history. In 2007, the share price of Citigroup dropped from $50 to $3.5.

Overview of the professional conducts of the CEOs of these financial institutions reveals that their conducts are not in their primary interests because their business practices were unethical and unprofessional. For example, Lehman Brothers hid more than $50 billion worth of loans and classified them as sales. With the help of the auditor, Ernest, and Young, Lehman Brothers manipulated the accounting book to fool financial community. Moreover, executives of Bear Stearns were charged with frauds, and one of the executives got 8-year imprisonment for fraud. An investigation carried out against the Countrywide Financial revealed that the senior executives were writing the riskier loans despite a warning that the company might face challenges to recover these loans. The bad conduct of the CEOs of these companies resulted in the loss of wealth of shareholders. For example, the share price of the Citigroup dramatically slashed down leading to a decline in wealth of shareholders. Moreover, the collapse of Lehman Brothers made the shareholders lose their entire investment. (Wiggins, Piontek, & Metrick, 2014). The issues caused a series of rivalries between the shareholders of these companies forcing the shareholders to file legal suits against the CEOs of Citigroup, Lehman Brothers, Bear Stern and Countrywide Financial.

PART 2

This study carries out the multiple regression analysis of the housing data in Appendix 1 collected from Boston Globe in real estate pages in 1990. (Wooldridge, 2009) The data are the homes sold in Boston area, and the variables of the data are revealed below:

VARIABLES

1

price house price, in dollars

2

assess assessed value in dollars

3

bdrms number of bedrooms

4

lotsize size of lot in ft2 (square feet)

5

sqrft size of a house in ft2 (square feet)

6

lprice log (price)

dependent variable

7

lassess log (assess independent variable

8

llotsize log (lotsize)

independent variable

9

lsqrft log (sqrft)

independent variable

The study develops the following null hypothesis to investigate the effect of a number of bedroom, lot size, and size of the house on housing prices.

Null Hypothesis

The number of bedroom, lot size and size of the house have an effect on the housing prices.

The paper develops the multiple regression to test the hypothesis using the level of significant (p-value). When the p-value is less than 5%, the study rejects the null hypothesis. However, if the p-value is greater than 5%, the study will fail to reject the null hypothesis revealing the study will accept the null hypothesis. The output of the multiple regression analysis is presented below, and based on the results of the regression analysis, the study accepts the null hypothesis because the p-value is greater than 5%.