using inside job to teach business ethics (jbe-2013)

8/21/2019 Using Inside Job to Teach Business Ethics (JBE-2013)

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UsingInside Jobto Teach Business Ethics

Ernest N. Biktimirov1Goodman School of Business

Brock University500 Glenridge Ave

St. Catharines, Ontario, Canada, L2S 3A1e-mail: [email protected]: (905) 688-5550 x 3843

fax: (905) 378-5723

Don CyrGoodman School of Business

Brock University500 Glenridge Ave

St. Catharines, Ontario, Canada, L2S 3A1e-mail: [email protected]

phone: (905) 688-5550 x 3136fax: (905) 378-5723

Published in theJournal of Business Ethics 117 (1), 2013, 209-219

The final publication is available athttp://www.springerlink.com/openurl.asp?genre=article&id=doi:10.1007/s10551-012-1516-y

Citation information:

Biktimirov E. N. and D. Cyr. (2013). UsingInside Jobto teach business ethics,Journal of Business Ethics117 (1), 209-219. DOI: 10.1007/s10551-012-1516-y

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Abstract This article recommends the filmInside Jobas an effective teaching tool for

illustrating the ethical issues that surrounded the global financial crisis of 2008 and the

subsequent economic downturn. The study discusses issues such as the revolving door, conflicts

of interest, fiduciary duty, executive compensation, and financial regulation. The presentation of

each ethical issue comprises suggested questions, background information, and guides to specific

sections of the film. An overview of the film is provided as well.

No form of art goes beyond ordinary consciousness as film

does, straight to our emotions, deep into the twilight room

of the soul.

Ingrid Bergman

Keywords Conflicts of interest Executive compensation Fiduciary duty Financial crisis

Financial regulation Inside Job Revolving door Teaching business ethics

Abbreviations Chief executive officer (CEO) Collateralized debt obligation (CDO)

Commodity Futures Modernization Act (CFMA) Commodity Futures Trading Commission

(CFTC) Credit default swap (CDS) Over-the-counter (OTC) Securities and Exchange

Commission (SEC)


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Introduction

The global financial crisis of 2008 forced millions of people out of their jobs and homes and had

an estimated cost of more than $20 trillion. Given its profound impact, the financial crisis has not

only been widely discussed in the media and analyzed in academia, but it has also been

examined in a film. The widely acclaimed 2010 documentaryInside Job, which was written,

directed, and produced by filmmaker Charles Ferguson, investigates the events leading up to,

during, and after the financial crisis. The film focuses on the complex ethical issues related to the

financial services industry and the industrys relation to the crisis. On its release in October

2010,Inside Jobwas immediately well received by both the viewing public and film critics.

Narrated by actor Matt Damon, this informative, disturbing, ironic, and enthralling film won the

Directors Guild of America and Writers Guild of America Awards as well as an Oscar for Best

Documentary Feature in 2011.

This article proposes the filmInside Job as an effective teaching tool to illustrate the

ethical issues that surrounded the crisis and the subsequent economic downturn. Through

extensive research and interviews with key financial insiders, politicians, journalists, and

academics; the film highlights the ethical questions that involved the financial industry,

government, and academia.

Teaching business ethics presents pedagogical challenges, even for experienced

instructors. To address these challenges, instructors use various teaching methods that range

from traditional lectures and case studies to interactions with convicted white-collar criminals

(Sims and Felton, 2006). However, an increasing body of the education literature focuses on the


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use of film to capture the students attention, to illustrate vividly abstract concepts, and to

generate stimulating discussions. Giacalone and Jurkiewicz (2001) highlight several of the

educational benefits from the use of film, such as bringing realism to the topic of ethics,

demonstrating ethical issues within a systematic context, and providing students with an

entertaining educational process.

The literature comprises several examples of films as teaching tools. Berger and Pratt

(1998) propose the use of Glengarry Glen RossandHouse of Gamesto examine business

communication ethics in the classroom. Shaw (2004) notes the ability of popular films, such as

Philadelphia, The Death of a Salesman, and Wall Street, to raise ethical awareness and to

emphasize the importance of moral character. Harrison (2004) suggests the use of two Australian

feature films, The Man Who Sued Godand The Bank, to stimulate classroom debate in business

ethics courses. Most of these films though are based on fictional characters and situations, but

the filmA Civil Actiontells the true story of the death of several children and adults from

leukemia, presumably because of contaminated drinking water. Roper (2004) uses this film to

discuss issues like the role of government in regulating business activity. To discuss three

models of practical ethics, Van Es (2003) proposes the film The Insiderthat portrays the true

story about whistle blowing within the tobacco industry.

Several studies use films to explore different ethical issues specifically in finance

courses. For instance, Dyl (1991) proposes the film Wall Streetfor discussing such issues as

insider trading, the use of nonpublic information, and the costs and benefits to society of

takeovers and corporate restructurings. Chan et al. (1995) suggest Other Peoples Moneyto

illustrate the different issues, such as the social responsibility of a firm, that surround corporate

restructuring. Similarly, Nofsinger (1995) uses the takeover of RJR Nabisco, depicted in the


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movieBarbarians at the Gate,to address ethics and social responsibility in an undergraduate

corporate finance course.

Indeed, because of the obvious popularity of the use of films as teaching tools, Sony

Corporation produced a special teaching guide (Partnoy, 2010) forInside Job. The main focus of

this study is to discuss the potential use ofInside Jobto illustrate the ethical issues specifically

manifested in the recent financial crisis.

The article is organized as follows. An overview of the film is followed by a discussion

of the ethical issues highlighted by the film, including the revolving door, conflicts of interest,

fiduciary duty, executive compensation, and financial regulation.Each discussion comprises

suggested questions, background information, and a guide to specific sections of the film. The

final section provides a conclusion. The appendix summarizes the materials available on the

films website.

Overview

The filmInside Job is 1 hour and 48 minutes in length and, after a brief introductory segment, is

divided into five distinct sections: How We Got Here, The Bubble, The Crisis,

Accountability, and Where We Are Now.

Introductory Segment (012:04)

The introductory segment of the film provides an overview of the financial crisis through

a synopsis of its impact on Iceland. In particular, it discusses the effects of the deregulation and


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privatization of the countrys banking system that allowed Icelands three national banks to

borrow an amount equal to 10 times the countrys gross domestic product over five years

through 2008. The financial downturn led to the collapse of the three banks. And, within six

months, the downturn led to a tripling of the countrys unemployment rate.

Part I: How We Got Here (12:0531:00)

Part I of the film suggests that in recent years a series of increasingly severe financial crises

occurred in the United States largely due to deregulation and the establishment of large

integrated and interdependent investment, insurance, and banking firms. In particular, in the late

1980s, deregulation ultimately led to the collapse of hundreds of savings and loans companies.

During the 1990s, the subsequent growth of the derivatives securities markets, the political

influence of the financial industry, and the belief in the concept of market efficiency all helped to

continue this policy of deregulation. The role of the deregulated investment banking industry in

the dot-com investment bubble and its subsequent collapse in 2001 is reviewed, along with

numerous cases of illegal and fraudulent activities since deregulation. This section also explores

the question of why incidences of unethical and criminal activities appear to be more frequent in

the financial sector of the economy.

At the close of Part I, the film provides a succinct summary of the process that led to the

crisis. It calls this process the securitization food chain. By 2001, banking profits had greatly

increased. This increase was in part fueled by debt contracts created when retail financial

institutions sold mortgage contracts to investment firms that then bundled them, along with other

forms of personal debt, into investments known as collateralized debt obligations (CDOs). The


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investment banks then sold the CDOs, ultimately transferring the risk of repayment from the

originating financial institutions and themselves to the investors who purchased them. As a

result, the original lenders no longer had any invested interest in the credit worthiness of the

borrowers.

Part II: The Bubble (20012007) (31:0157:00)

Part II of the film reviews the events that followed and led up to the crisis as a result of

the securitization food chain. Over 10 years, the easy flow of credit and subprime mortgage

lending led to the real estate housing boom and substantial profits for subprime mortgage lenders

such as Countrywide Financial. At the same time, the investment banks were paying out huge

bonuses and were themselves borrowing heavily to buy an increasing number of debt contracts in

order to create and sell the lucrative CDOs. The film also reviews the role of AIG in the crisis.

AIG sold huge quantities of credit default swaps (CDSs) that theoretically provided insurance

against losses that an investor might incur from CDOs. However, because of a lack of regulation,

AIG was not required to maintain a reserve in the case of potential losses and the resulting

payouts associated with the swaps. Instead, the profits made by AIG in selling CDSs were often

used to pay huge bonuses within the firm.

In a paper presented in 2005 at an annual meeting of the worlds central bankers, then-

chief economist Raghuram Rajan of the International Monetary Fund questioned the practice of

paying large bonuses within the banking and insurance industry (Rajan, 2005). He argued that

such incentive structures encourage bankers to take huge risks that can inevitably destroy the

firms for which they work. At this point the film explores the issue of whether individuals in the


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investment industry would willingly put their firms at risk. The question is indirectly answered

through various video clips and interviews that highlight the excesses and cultures of extreme

risk taking, including illegal activities, in the investment banking industry.

The film also examines the specific activities of investment banks to explore their

potential awareness of the impending financial crisis. In the end, a number of hedge funds as

well as banks like Goldman Sachs and Morgan Stanley made millions in the subsequent

downturn through a strategy of selling risky CDOs to pension funds and other unsuspecting

investors, while betting against the CDOs through the CDS market.

Finally, the film explicitly considers the role of the three credit rating agencies: Moodys,

S&P, and Fitch. The film provides excerpts from the congressional hearings in which the credit

agencies consistently defend the high credit ratings that they supplied as simply opinions.

Part III: The Crisis (57:011:17:18)

Part III of theInside Job focuses on the actions of government regulators up to and during the

crisis. By 2007, the housing bubble had burst, and foreclosures had started to increase. Lenders

were no longer able to sell their loans to the investment bankers, and as the loans defaulted,

lenders started going bankrupt. The market for CDOs had also collapsed, and many investment

banks were left with loans that they had purchased through debt financing but were now unable

to sell as CDOs. The film provides evidence that even though consumer advocacy groups and the

FBI gave significant warnings with regard to mortgage fraud and predatory lending in the years

before the crisis, the Federal Reserve Board took very little action.


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By March 2008, Bear Sterns was close to bankruptcy and was purchased by Morgan

Chase. By early September 2008, the federal government announced the takeover of the

mortgage lenders Fannie Mae and Freddie Mac, along with a significant stake in AIG insurance

to prevent its collapse. Meanwhile the investment bank Lehman Brothers filed for bankruptcy.

The film notes that during this period the credit rating agencies continued to give high

investment grade ratings to Bear Sterns and Lehman Brothers, even within days of their failure.

They also gave the same high ratings to AIG, Fannie Mae, and Freddie Mac right up to the time

of their bailouts.

The film explores the lack of planning on the part of financial regulators for the

possibility of bankruptcy for a major investment bank. In particular, the Federal Reserve did not

anticipate the global impact of Lehman Brothers bankruptcy on the short-term commercial

paper market. The film details the sequence of events, including the role played by the Federal

Reserve, and the impact of the commercial credit crisis that followed.

In October 2008, Congress provided Henry Paulson, the secretary of the Treasury, and

Ben Bernanke, the chairman of the Federal Reserve, with $700 billion to bail out the investment

banks. The film notes that after bailing out and taking control of AIG, the Treasury and the

Federal Reserve paid out the firms CDS obligations to the various investment banks (of which

the largest amount owed was to Goldman Sachs) at 100% of their value rather than negotiating

lower payments. At the same time, AIG was forced to give up its right to sue any of the

investment banks. The film raises the issue of a conflict of interest given that Henry Paulson was

a former CEO of Goldman Sachs.

Part IV: Accountability (1:17:19 1:33:28)


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Section IV highlights the fact that the executives of the top investment banks appear to have lost

nothing in the crisis. This portion of the film also calls into question the issue of the role and

composition of the board of directors in such organizations. The film provides numerous

examples of blatant excesses in terms of senior executive compensation both before and after the

crisis. The narrative also highlights the political power of the financial services industry by

pointing out that between 1998 and 2008 the industry spent more than $5 billion on lobbying and

campaign contributions and, with the use of more than 3,000 lobbyists, continues to fight

aggressively against financial reform.

The film proposes that the study of economics itself has been corrupted by the industry.

The film features interviews with several academic economists who support deregulation and

outlines the various forms of compensation they received from the financial services industry. In

addition, the film lists several economic consulting firms and think tanks that employed

prominent academic economists for consulting purposes to advance the interests of the industry.

Part V: Where We Are Now (1:33:291:48:29)

Part V presents the hypothesis that the rise of the financial sector from the 1980s onward

coincides with broader socio-economic changes in the United States. In particular, the film notes

a decline in the nations economic competitiveness and its greater inequality of wealth. These

combined factors placed pressure on middle-income earners to enter into greater debt

facilitated by the financial services industryto finance their houses, health care, and education.


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The film also contends that the regulatory reforms enacted in mid-2010 were relatively

weak at best. The term a Wall Street government arises and the film points out that, as of mid-

2010, no single senior financial industry executive had been prosecuted or arrested, and no single

firm had been prosecuted for accounting or securities fraud. The film concludes that the financial

services industry turned its back on society, corrupted the political system, and brought the world

economy to the brink of disaster. The film also observes that the key elements remain in power

and that change needs to take place.

Ethical Issues

Inside Jobcan be discussed in a dedicated course on business ethics or in any number of

business courses. The film highlights many interesting and in some cases complex ethical issues,

which can be considered in the context of traditional ethical theories. The teaching of business

ethics predominantly focuses on utilitarian and deontological (rights-based) ethical theories as

frameworks for exploration and discussion (e.g., Champoux, 2006; Dolfsma, 2006; McDonald

and Donleavy, 1995; Ostapski et al., 1996; Wong and Beckman, 1992).

Utilitarianism bases ethical decisions on the ratio of benefits to costs for the greatest

number of people in society (Gandz and Hayes, 1988). That is, if the overall benefits to the social

good exceed the costs, the decision is ethically justified. However, critics of utilitarianism

suggest that justice and other widely embraced principles can be overlooked or minimized in

ethical decisions and that a purely utilitarian approach can easily lead to self-serving ethical

decisions (Wong and Beckman, 1992). Deontological theory is based on the proposition that

individuals have certain rights that must be respected regardless of the costs to keep the moral


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fabric of society intact (Dolfsma, 2006; Wong and Beckman, 1992). These two theories present

useful contexts within which students can frame the various ethical issues in the film. Wong and

Beckman's (1992) integrated moral analysis also presents a possible framework for

consideration.

An instructor can use the film in one of two ways in a classroom setting. First, the

instructor can play the film in its entirety in one class period. He or she might stop several times

to discuss ethical concepts as they arise or allow the film to play without interruptions and then,

at the end, ask the students to identify ethical issues. Given the running time of the movie, 1 hour

and 48 minutes, the required class time for this approach is between 2.5 and 3 hours. Second, the

instructor can show shorter video clips from the film to illustrate specific ethical concepts as they

are discussed during a course. To facilitate either approach, this section of the paper presents

discussion questions on different ethical issues raised in the film, the starting and ending times

for related video clips, and some background information.

The Revolving Door

What is a revolving door? What benefits are derived from the exchange of employees between

the private and government sectors? What ethical issues might arise because of the revolving

door? Should individuals working as financial regulators be allowed to leave their positions for

more lucrative positions in the financial services industry?

The revolving door refers to the movement of individuals from legislative, political, or

regulatory positions into positions within the industries or associated lobbying firms over which

they previously had influence. The revolving door also refers to the political appointment of


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former industry executives into positions with significant influence over regulations that relate to

their former firms. From a utilitarian perspective, the revolving door can offer several benefits to

both government and the private sector. Specifically, former industry executives bring first-hand

knowledge of, rich experience in, and influence on the private sector. This influence can be

especially useful in securing the private sector support needed for government policies. Firms

hire former government officials for various reasons including the desire to gain insider

knowledge of government work, to obtain access to influential individuals in government and

politics, and to increase the effectiveness of lobbying efforts for favorable government policies

and regulations. Despite these benefits, the revolving door can also lead to serious ethical

debates, some of which are highlighted in the film. From a deontological perspective, students

might consider that the revolving door potentially jeopardizes the right of individuals and society

to be represented by unbiased government officials.

Movement of regulators into positions with regulated firms (5:036:15)

This segment of the film deals with the sequence of events in Iceland and suggests that one

reason that the bank regulators failed to protect the public interest was the effect from the

revolving door. Because of the huge discrepancy in financial compensation between individuals

working as regulators and related positions within regulated firms, talented regulators frequently

switch sides to represent the interests of the firms that they formerly regulated. In this section

of the film, Gylfi Zoega, faculty chairman of the Department of Economics at the University of

Iceland, talks about the excessive number of highly paid lawyers who were present to represent

the Icelandic banks whenever regulators called on them. If a regulator appeared to be


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exceptionally astute, he or she was inevitably hired by one of the banks. As a result, one-third of

the Icelandic banking regulators went to work for one of the countrys banks over the period

leading up to the 2008 financial crisis. The segment concludes with an iconic image of a

revolving door and the question raised by Gylfi Zoega: This is a universal problem? In New

York, you have the same problem, right?

Movement of industry executives into government positions (1:37:301:40:38)

This segment highlights the other side of the revolving door, namely, when former key industry

executives accept appointments to legislative and regulatory positions. Given their close

connections to the private sector, the question is whether these individuals act in the best

interests of the public or serve the interests of their former industry?

Specifically, the film contends that although Obamas election platform called for change

and the need to regulate the financial services sector, the regulatory reforms enacted in mid-2010

were relatively weak at best. The film attributes much of the failure in regulatory reform to the

appointments of former industry executiveswho were heavily involved in policy-making

positions leading up to the financial crisisto key regulatory and advisory positions in the

Obama administration. Former director of the Greenlining Institute Robert Gnaizda refers to the

Obama administration in the film as a Wall Street government. The film provides numerous

examples to back up Gnaizdas claim.

For example, William Dudley, the former chief economist at Goldman Sachs, is

appointed as president of the New York Federal Reserve. The film recalls that Dudley and Glen

Hubbard, the dean of the Columbia School of Business, prepared a paper in 2004 for Goldman


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Sachs titled How Capital Markets Enhance Economic Performance and Facilitate Job Creation.

The paper expounds the benefits of the credit derivatives markets and the securitization chain

and was widely read. Other examples noted in the film include the appointment of Gary Gensler

to chair the Commodity Futures Trading Commission. Gensler, a former Goldman Sachs

executive, helped ban the regulation of derivatives markets in 2000. Obama chose Mary

Schapiro to head the SEC. The former head of the Financial Industry Regulatory Authority, the

industrys self-regulatory body, Shapiro is known for her efforts on behalf of the industry to

weaken regulation before the financial crisis.

Conflicts of Interest

What is a conflict of interest? What ethical issues can result from a conflict of interest? What

different types of the conflicts of interest are highlighted in the film? How can possible conflicts

of interest be alleviated?

A conflict of interest can be defined as a situation in which a person has a private or

personal interest sufficient to appear to influence the objective exercise of his or her official

duties as, say, a public official, an employee, or a professional (MacDonald et al., 2002, p. 68).

An important element of this definition is that an individual does not need to make a biased

decision for the conflict of interest to manifest itself. Even if an individual resists temptation to

pursue personal interests and performs his or her duties objectively, simply the presence of the

conflict corrodes trust and is harmful to a profession. The film highlights several conflicts of

interest that contributed to the financial crisis. The ethics can again be framed within a

deontological perspective.


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Analysts Conflicts of Interest (19:0119:50)

The description of the dot-com stock market bubble of the late 1990s and its collapse in 2001

illustrates analysts conflicts of interest. During that period, many large investment banks

promoted risky Internet stocks even though subsequent investigations show that in many cases

the banks own analysts expressed extreme skepticism of the financial strength of these Internet

companies. The issue resulted in law suits and the $1.4 billion settlement mentioned in the film.

A flawed compensation structure contributed to the unethical behavior of stock analysts.

Specifically, investment firms paid them based on the level of business that they brought to the

firms and not the accuracy of their recommendations. Therefore, analysts had strong incentives

to report inflated ratings for stocks to attract investment banking clients. Palazzo and Rethel

(2008) classify this conflict of interest as a personalorganizational, because it is inherent in the

firms organizational structure.

Credit Rating Agencies Conflicts of Interest (54:5557:00)

The credit rating agencies played a significant role in the securitization food chain that led to the

financial crisis. The investing public, in general, expects credit rating agencies to provide

unbiased professional opinions with regard to the credit worthiness of securities. Investigations

and congressional hearings into the cause of the financial crisis have subsequently indicated that

the belief in this roleand particularly to the obligations of credit rating agenciesis largely

misinformed.


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This section of the film highlights the hundreds of millions in fees that investment banks

paid to Moodys, S&P, and Fitch to provide relatively high-risk CDOs with triple-A credit

ratings. The film presents excerpts from congressional hearings in which rating agencies

consistently defend their ratings as simply opinions and as such could not be relied on. The

evolution of the credit rating business and its regulation, or lack thereof, represents an interesting

basis for class discussion on the conflicts of interest (see Cane et al. (2011) for a summary of the

issues and regulation involving credit rating agencies).

Academic Conflicts of Interest (1:22:251:33:27)

This segment presents the conflicts of interest in academia surrounding the crisis. Academics and

their research are expected to provide objective, unbiased opinions. However, very few academic

economists foresaw the financial crisis, and even afterward some continue to argue against

reforms. The film indicates that in many cases leading academic economists were paid healthy

consulting fees by financial services firms while simultaneously helping to shape public debate

and policy.

Academic economists interviewed or featured in this segment include Martin Feldstein,

Harvard University; Glen Hubbard, dean of the Columbia Business School; Laura Tyson,

University of California Berkley; Ruth Simons, president of Brown University; Larry Summers,

president of Harvard University; Frederic Mishkin, Columbia Business School; Richard Portes,

London Business School; and John Campbell, chair of the Department of Economics of Harvard

University.


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The film highlights the role that these individuals played as economic advisors to the

government and also the large consulting fees and board membership fees that they received

from numerous financial services firms. For example, economic consulting firms such as The

Analysis Group, Charles River and Associates, Compass Lexicon, and the Law and Economics

Consulting Group all employed prominent academic economists for consulting purposes.

The most disturbing aspect of this segment is the academics responses and reflections

when asked whether a conflict of interest arises when they are financially compensated for

preparing reports or providing their opinions on particular issues. In addition, the question arises

on whether such financial entanglements should be clearly reported as is frequently the case in

medical research. The responses of Glen Hubbard, Frederic Mishkin, and John Campbell, as

portrayed in the film, are particularly weak and disappointing.

The segment focuses on two reportsone prepared by Mishkin in 2006 and the other

prepared by Portes in 2007. Both reports were underwritten by the Icelandic Chamber of

Commerce, and both attested to the strength, stability, and financial health of the Icelandic

banking system. In neither case do the reports indicate that the authors were paid a fee.

In discussing this issue, an instructor can mention two examples of increased emphasis on

ethics in academia following the release of the film. First, referred to as theInside Jobeffect, the

Columbia Business School subsequently adopted a new conflict-of-interest policy that requires

professors to disclose all outside activities, including consulting, that create or seem to create

conflicts of interest (Poliak and Roth, 2011). Second, the broader issue of requiring a code of

ethics for the economics profession can be raised (DeMartino, 2011) and discussed in relation to

the American Economic Associations decision to consider the adoption of a code of ethical

standards (Chan, 2010).


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In several cases, the belief in deregulation as fundamental to a well-functioning market

system might have led many politicians and economists to choose actions that would be justified

in their view based on a utilitarian perspective. Again, however, the rights of individuals to both

perceptually and effectively unbiased information from academic and government leaders is

paramount under a deontological approach to the ethical issues of disclosure of conflicts of

interest.

Fiduciary Duty and the Investment Industry

What is fiduciary duty? How do the concept and legal obligations of fiduciary duty apply to the

investment industry? What are the fiduciary duties of an investment advisor? What are his or her

ethical requirements? What are the fiduciary and ethical obligations of a board member?

In general, the concept of fiduciary duty is embedded in common law and comes from the

Latin word for trust. Someone acting in a fiduciary role must act for the benefit of the person for

whom he or she holds the fiduciary duty to the exclusion of any contrary interest (Richards,

2006). Within the investment industry, whether an investment firm or its advisors are in a

fiduciary role depends somewhat on their actions. Although the brokerage function of facilitating

the buying and selling of securities does not involve a fiduciary responsibility, providing

continuous comprehensive investment advice is considered a fiduciary role. Richards (2006)

suggests that to fulfill fiduciary responsibilities in providing investment advice, one must (a) put

the clients interests first, (b) act in utmost good faith, (c) provide full and fair disclosure of all

material facts, (d) not mislead clients, and (e) divulge all conflicts of interest to clients.


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Brokers Fiduciary Duty (49:3054:55)

Whether the investment firms that sold CDOs had a fiduciary duty has been the focus of both

congressional hearings and legal proceedings. This section of the film focuses largely on the

activities of Goldman Sachs and whether its representatives violated the concept of fiduciary

duty in selling CDOs to their clients. In addition to selling CDOs that Goldman Sachs obviously

believed were of suspect quality, the firm took positions from which it would clearly benefit

given a collapse in the CDO market. Goldman Sachs executives argued that they were simply

satisfying the brokerage or market-making function by facilitating the buying of CDOs and did

not have a fiduciary responsibility.

Fabrice Tourre, a Goldman vice-president, was ultimately the only Goldman employee

named in a SEC case brought against the firm in 2010. The SEC alleged that Goldman Sachs had

materially misstated and omitted important facts with regards to the sale of a CDO product to

various investors. The case was settled for $550 million, and Goldman did not admit to any

wrong doing.

Whereas the film clearly blames Goldman Sachs for failing to protect its clients

interests, this situation is not trivial. Legendary investor Seth Klarman (Klarman and Zweig,

2010) notes that, while a broker has a definite responsibility not to lie, he or she does not owe

fiduciary duty on a trade. In other words, a broker is not required to warn clients about low-

quality investments. Similarly, betting against a client on a transaction should not be a concern if

a broker does it to hedge his or her exposure to the security purchased by the client. Thus, the

difference between fiduciary duty and deontological ethics lies at the heart of the debate and

makes for an interesting class discussion.


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Executive Compensation

Can executive compensation be excessive? Is executive compensation related to firm

performance? Was executive compensation affected by the financial crisis?

The size of executive compensation remains a controversial issue (Nichols and

Subramaniam, 2001; Harris, 2009). The growing disparity between executive and average

workers compensation and the gap between domestic and foreign executive compensation

suggest that executive compensation is excessive. In contrast, short supply and huge demand for

talent in the executive labor market and the correlation between firm performance and executive

pay suggest that executive pay is equitable.

Magnitude of Executive Compensation (42:1744:58)

The film clearly argues that executive compensation is excessive. This segment of the film

highlights a flaw in a compensation system that encourages executives to put their firms at risk

because their bonuses are based on short-term profits. In addition, interviews and video clips that

include aerial shots of mansions, yachts, and private jets provide an analysis of the wealth,

excesses, and motivations of many individuals working in the investment banking industry.

In the conclusion of this segment, Jonathan Alpert, a therapist with many Wall Street

clients, speaks to the aggressive, risk-taking personalities that characterize the industry.

Consistent with this observation, Boddy (2011) suggests that the compensation system of large


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financial firms appeals to psychopaths and that these corporate psychopaths played a major role

in causing the global financial crisis.

Executive Compensation and Firm Performance (1:17:201:20:55)

Although executive compensation is expected to be closely tied to the firms performance,

executives of the top investment banks appear to have lost nothing in the crisis. This segment

addresses the disconnect between firm performance and executive compensation.

The film provides glaring examples of excessive compensation before and after the crisis.

For example, between 2000 and 2007, the top five executives at Lehman Brothers made over $1

billion. Between 2003 and 2008, Countrywides CEO Angelo Mozilo made $470 million$140

million of which came from the sale of his stock in Countrywide 12 months before the firms

collapse. Stan ONeil, the CEO of Merrill Lynch, received $90 million in 2006 and 2007 before

his company was ruined. On his resignation, he received an additional $161 million in severance.

His successor took home $87 million in 2007 and, in December 2008, after receiving the bailout

package from the Federal Reserve, paid out billions of dollars in bonuses within the firm. Even

after AIGs financial products division posted a loss of $11 billion in March 2008, the company

retained the head of the division as a consultant for a fee of $1 million a month. The film raises

questions about the quality of the job performed by these firms boards of directors in offering

such generous compensation schemes in the face of poor performance.

For background information about ethical issues associated with executive compensation

and recommendations for addressing them, an instructor can use Perel (2003) and Moriarty

(2005).


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Ethics in the Financial Industry

What is the level of ethics in the financial industry compared with those of other industries?

What is the relation between deregulation and the level of ethics in the financial industry?

Level of Ethics in the Financial Industry (19:5222:49)

Among different industries, the financial industry seems to have the lions share of cases

of fraud and unethical behavior. The film explains this high occurrence partially as the result of

the advent of deregulation. This view is in line with that of Green (1989) who suggests that

deregulation and new technologies that replace face-to-face contact increase opportunities for

unethical behavior. This segment lists a number of cases of laundering money for such things as

Irans nuclear program, bribery, and fraudulent accounting practices, including the aiding of the

infamous Enron Corporation in its accounting deceptions. Interviews with various lobbyists and

officials also hint at the question of why the financial sector appears to have a higher level of

unethical and criminal activities than other sectors of the economy.

Financial Regulation

What are the arguments for and against the regulation of the financial industry? Did the

deregulation of the financial industry contribute to the financial crisis?


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The importance of the financial industry for the economy, the complexities of financial

instruments, the significance of trusting relationships, and the opportunities for fraud are some of

the reasons for the regulation of the financial industry. The lack of effective regulation might

lead to excessively risky behavior by financial institutions. However, the financial industry has

continually objected to regulation because it increases its cost of doing business and limits the

industrys ability to take advantage of profitable opportunities.

The film offers several segments with detailed discussions on regulation and its impact

on specific sectors of the financial industry.

Decline of Financial Regulation (12:0618:27)

This segment suggests that since the 1980s the U.S. financial sector has been undergoing a

steady decline in financial regulation. The erosion of the regulatory landscape led to a series of

increasingly severe financial crises, while the financial industry appeared to continue to profit.

Prior to the 1980s, most banks were local businesses that were prohibited from making

risky investments with their depositors savings. Investment banks were largely financed with

equity supplied by their partners, who, as a result, were fairly conservative in terms of their

investment strategies.

In 1981, President Ronald Reagans appointment of Donald Regan, the CEO of the

investment bank Merrill Lynch, as treasury secretary started a 30-year period of financial

deregulation. This process of deregulation was largely supported by the economics profession

and, of course, the financial industry and its lobbyists. Investment banks started to go public,

which provided them with huge amounts of shareholders capital and an increasing appetite for


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risk. Investment banks grew at a phenomenal rate. In 1972, for example, the investment bank

Morgan Stanley had approximately 110 employees working out of one office and capital of $12

million. In 2010, the firm had approximately 50,000 employees in numerous offices worldwide

and capital of several billion dollars.

The film highlights the dangers of financial deregulation with a discussion of the

relaxation of controls on investments of savings and loan companies in 1982. This deregulation

allowed savings and loans to make risky investments with their depositors money. As a result,

hundreds of such institutions had collapsed by the end of the decade; the cost to the U.S.

taxpayer was $124 billion. Thousands of savings and loan executives served prison terms for the

mismanagement and theft of the savings of their depositors.

Facilitated by deregulation, the subsequent consolidation of the financial services sector

by the late 1990s resulted in fewer, larger firms whereby the failure of any one could threaten the

whole system. The film provides the example of the 1998 merger of the banking giant Citicorp

and the insurance firm Travelers Group to form Citigroup, the largest financial services company

in the world. Although this merger violated the GlassSteagall Act of 1933 at the time, which

prevented banks from engaging in the higher risk investments allowed by insurance firms, it was

not challenged by the Federal Reserve. Subsequent legislation (the GrahamLeachBliley Act)

was passed in 1999 that cleared the way for similar consolidations. As a result, large financial

institutions could combine the activities of commercial banking, investment banking, and

insurance with significant monopoly and lobbying power.

In the conclusion of this segment, George Soros, chairman of Soros Fund Management,

presents a vivid metaphor for regulation and deregulation by using water tight compartments of

an oil tanker.


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Regulation and Derivatives Market (22:4926:57)

This segment focuses on the derivatives market that by the late 1990s ballooned in size to $50

trillion and remained largely unregulated. Advances in computer technology and the application

of advanced mathematical techniques to financial innovation fed the growth in the design and

use of complex derivative securities at that time. The general premise among economists and

politicians was that the derivatives market provided greater efficiency and, therefore, stability in

the financial system.

The film presents the sequence of events in 1998 when the Commodity Futures Trading

Commission (CFTC), then chaired by Brooksley Born, proposed increased regulations for the

OTC derivatives market. The CFTCs proposals were met with aggressive resistance from the

U.S. Treasury Department, headed by economist Larry Summers; Alan Greenspan, chair of the

Federal Reserve; the SEC; and the banking industry in general. Subsequently, in 2000, Congress

passed the Commodity Futures Modernization Act (CFMA), largely spearheaded by Senator Phil

Graham, which essentially exempted the OTC derivatives market from regulation on the

argument that such markets were of great value to the economy.

Stout (2011) provides useful background information on derivatives and their legal

history. Stout suggests that the CFMA is the main cause for the financial crisis of 2008.

Regulation and Mortgage Industry (33:3934:43)


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This segment deals with the regulation of the mortgage industry. The Home Ownership and

Equity Protection Act of 1994 gave the Federal Reserve Board broad powers to regulate the

mortgage industry. However, Greenspan, as chairman of the Federal Reserve, refused to use it.

The film features an interview with Robert Gnaizda, the former director of the

Greenlining Institute, a powerful consumer advocacy group. Gnaizda, who met with Greenspan

on a regular basis, was particularly concerned that, because of the complexity of sophisticated

lending vehicles such as adjustable rate mortgages, the average individual might be unable to

discern whether he or she was entering a fair deal. However, Greenspan rejected any efforts to

enact regulations that would limit the activities of the mortgage industry.

Regulation and Investment Banks (34:4437:20)

This segment examines the status of regulation in the investment industry. Specifically, through

video clips of congressional hearings, the film highlights considerable cutbacks experienced by

many critical departments of the SEC. For example, the staff of the Risk Management Office of

the SEC was reduced to just one person. These cutbacks significantly reduced the ability of the

SEC to fulfill its mission of protecting investors and maintaining market integrity. As the film

indicates, the SEC conducted no major investigations of the investment banks during the bubble.

Between 2001 and 2007, many investment banks borrowed heavily to buy a greater

number of debt contracts to create and sell more lucrative CDOs. The film indicates that in 2004

Henry Paulson, then-CEO of Goldman Sachs, along with other executives, successfully lobbied

the SEC to relax leverage limits for investment banks. By 2007, the leverage of the five major

investment banks ranged from between 25:1 to 33:1, which made them inherently more risky.


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Political Power of Financial Industry (1:20:551:22:24)

This segment highlights the political power of the financial services industry since the crisis. The

film argues that investment banks appear to be more powerful and concentrated than they were

prior to 2008. Between 1998 and 2008, the financial industry spent more than $5 billion on

lobbying and campaign contributions. Employing over 3,000 lobbyists, they continue to fight

aggressively against financial reform since 2008.

Conclusion

The financial crisis of 2008 affected millions of individuals and economies worldwide, and its

impact continues today. Although the sequence of events and actions on the part of regulators

and the industry that led to the crisis are relatively complex, ethical questions are at the heart of

many of the issues related to the crisis. The filmInside Job offers an enthralling look at the

events leading up to, during, and after the financial crisis through video clips and interviews,

providing a clear explanation of its causes. This article recommends the use of theInside Jobin

the classroom as an efficient tool to explore many of these ethical issues, such as conflicts of

interest, fiduciary duty, executive compensation, and financial regulation.

The film also provides an informative overview of this very important event in world

history, which has the potential to affect the economic opportunities of a generation. The 2008

economic crisis and films such as theInside Jobhave brought to the forefront important

questions regarding the power of the economic sphere over the political and civil society spheres.


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At the end of the film, Ferguson questions the ability of the Obama administration to introduce

and enact stricter regulation of the financial services industry. Indeed, many critics (e.g., Hall,

2012) suggest that to date reforms such as the DoddFrank Wall Street Reform, the Consumer

Protection Act, and the Consumer Financial Protection Bureau have been and will continue to be

largely ineffectual because of the extensive lobbying on the part of the financial services

industry.

The lack of an effective response on the part of many governments worldwide four years

after the crisis has no doubt resulted in a large fissure in global capitalism, reflected most

recently perhaps by the elections in France of a socialist government. In the United States, the

filmInside Jobhas played an important role in mobilizing a general civil society reform

movement. This movement is exemplified by Occupy Wall Street and the frequent mentions of

the film on many related websites.

In the recently published book Predator Nation: Corporate Criminals, Political

Corruption, and the Hijacking of America, Ferguson (2012) notes that as late as 2012 and despite

abundant evidence of wrongdoing, not a single criminal prosecution of a senior financial

executive related to the financial crisis has occurred. He makes the important point that such

criminal prosecution is not simply a matter of vengeance but a vital element in ensuring that re-

regulation is ultimately credible. Further, he argues that the impunity with which many in the

financial industry carried out such reckless actions and the personal gains made are indications of

a dysfunctional economy.

In contrast to Fergusons general condemnation of the financial services sector, Yale

economist Robert Shiller (2012) defends the field of finance in the recently released book

Finance and the Good Society. In particular, he argues that innovation in financial products and


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services contributes in many ways to the social good. In several instances he also attempts to

defend the high compensation within the sector and does not appear to be strongly in favor of

increased regulation. These two recent books highlight the complex and controversial nature of

the issues around the modern capitalist economy. Within this conversation, the filmInside Job

provides a valuable starting point for class discussion and debate on the ethical issues raised as a

result of the financial crisis and the broader question of what are credible fixes within the

politicaleconomic sphere.


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Appendix: Additional Materials

The website forInside Job(http://www.sonyclassics.com/insidejob) is a significant source for

background information and resources to facilitate the use of the film for classroom instruction.

This material includes definitions of many of the terms used, brief introductions of individuals

interviewed, and other related information. For example, the Jargon section of the website

(http://www.sonyclassics.com/insidejob/site/#/thejargon) as well as the films press kit

(Ferguson, 2010) define terms such as CDOsand mortgage-backed securities. In addition, the

Official Teachers Guide (Partnoy, 2010) is freely available on the films website and provides

additional details regarding the formation of mortgage-backed securities.

The Cast section of the website (http://www.sonyclassics.com/insidejob/site/#/cast)

presents short introductions of the individuals interviewed in the film. These individuals are

divided into seven groups and include academics and journalists as well as those who warned

us and those who might regret their comments. Individuals who declined to be interviewed

for the film are also listed.

The website provides a list of news articles and Internet resources that document past

criminal activities with which various firms in the financial services industry have been charged

and regulatory infractions for which they have paid substantial fees. A timeline beginning from

the GlassSteagall and the Securities and Exchange Acts of the 1930s highlights the major

events in the financial industry through the crisis.

In addition to the films website, the Fergusons (2012) book Predator Nation:

Corporate Criminals, Political Corruption, and the Hijacking of Americaprovides additional

background information on many issues highlighted in the film and discussed in this article, such


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as deregulation, rating agencies, and conflicts of interest in academia. Published two years after

the films release, the book picks up where the film left off with the opening chapter titled as the

last part of the film: Where We Are Now. The concluding chapter of the book addresses the

question What Should Be Done?


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