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W9 Corruption and Bad Faith.docx

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University of British Columbia
ECON 255
Ashok Kotwal

Week 9 Reading 8: Akerlof and Schiller - Corruption and Bad Faith − Consumer Protection  Often provided to protect consumers  Financial crisis: in the area of securities (or also known as people’s savings for the future), consumer protection is not provided people save money by investing in stocks, bonds, claims to retirement funds and life insurance  but, these are just implicit promises of future payments  to attract people’s interest to invest, various methods of scheming are created − False accounting = sale of snake oil  to claim it does something when it actually doesn’t  dome by misrepresenting the corporate books  either: creates artificially high profits, pay more to owners more than how much their shares worth, inflate the price of shares and sell them [Examples from the Past Three Recessions] − Typical principles involved: 1) simple because it always involve the violation of elementary principles of accounting regarding how much money can legitimately be taken, 2) complicated because the participants seek to shroud in complexity the violation of the simple principles [Case #1: Savings and Loans Associations and the Recession of 1991 / Saving&Loans (S&L) Crisis] − Public corporations managed people’s S&L  S&L represent the banks  they lend money for mainly mortgages − Progress towards the crisis: banks were deregulated  money lending occurred more aggressively because government acted as the guarantor of their deposits government will always bail out  Effects of deregulation: reduces the disincentives to get involved in corruption  led to the proliferation of bad loans  Effects of excessive money lending: it became a problem when inflation occurred  led to interest rate increases  loan becomes costly and not generating profitable return  the government wasn’t going to let this happen  so, clever accounting was instituted to allow S&L to stay in business − Hostile takeover bid:  Michael Milken discovered a way to reduce the cost of takeover  use the money obtained from the junk bond (other people’s money)  Junk bond  was discovered to be able to pay-off the stockholders  method known as “warrant” − The Coincidence: 1) the advent of junk bonds, 2) the hostile takeovers, 3) massive increases in executive pay  Symptom 1: the rising price of real estate  there was information asymmetry involved  this was also made possible by confidence people have in the system [Case #2: Enron and the Recession of 2001] − This phenomenon is related to the aftermath of stock market boom of the 90s − Enron: how accounting principles were first taken to their limit and then exceeded − Method #1 of ‘Enronisation’  Long term contracts for the sale or purchase of natural gas were to be accounted using market-to-market accounting  How it works: at the time the contra
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