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Philosophy 2074F/G
Michael Herbert

HIGH LEVERAGE FINANCE CAPITALISM: ETHICAL ISSUES AND POTENTIAL REFORMS – NEILSON  Involuntary poverty is usually a bad thing. Poverty, like war, often brings out the worst in people  Schumpter analyzed how all forms of capitalism have important creative and destructive phases and that there has been no golden age of capitalism without important destructive elements  Capitalism is by nature a form of method of economic change that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one  Leverage generally refers to the amount of money borrowed by an investor/;trader relative to the amount of secure capital owned or invested by the investor/trader  Leverage also can enable business investors to start and expand businesses and economic development projects with only ten to twenty percent of the cost of the investment project  Originally, hedging referred to an investment strategy designed to reduce rather than increase risk by investing some portion of investment resources in a direction relatively opposite to the main investment  The attraction of the modern hedge fund was more the high leverage than the hedging itself, that is, the higher return potential offered to investors through the high leverage  Types of products that hedge funds invested in expanded to include stocks, bonds and other debt products  Hedge funds and their investors engaged in triple high leverage  A more accurate name for a modern hedge fund might be a high leverage investment fund  The problem further intensifies when may hedge funds invest in the same direction and many of them experience deleveraging together, as happened in the high leverage, subprime mortgage and private equity leveraged buyout  Large, exponential losses by hedge funds are less a problem when investors are informed of and understand the high risks, invest and potentially lose their own money and can afford to lose their capital  The original purpose and practice of private equity firms was to invest long-term equity capital to develop and grow start up businesses in anticipation of long term returns  Since there is a transparency problem with PE-LBO firms it is difficult to determine the proportion of PE LBO firms that leans toward high debt leverage and cash dividend payments relative to investment in business/technology development  PE LBO firm borrows most of its investment capital from banks and other financial institutions  There is, in a sense double leverage here. More borrowed than invested money is used to buy a company  This can be very risky for the acquired company and the people and institutions making the loans to the PE LBO firms  Since banks made most othe loans to PE LBO firms, this contributed greatly to the banks enormous bad loans lossess  The traditional private equity firm invests in and develops the business content over the long term, such as in the development of new technologies  Subprime mortgages: when all did not go well, and incomes and or property values did not rise to meet the required increased mortgage payments or when incomes declines, the properties had to be sold. This often resulted in large losses for the investors and the bankers who held the loans as assets and or the people and institutions who bought packages of such subprime mortgages  Before the housing bubble burst, the subprime mortgages were very profitable for mortgage brokers who collected large fees and commission for originating and distributing the loans to others as parts of packages of structured investment vehicles and collateralized loan obligations with the overvalued homes as the weak collateral  Traditional banking is very different from the types of financial deal making of the current high leverage, subprime, corporate, consumer and banking financial crisis  The loans are considered relatively high risk because the borrowers before or after the loans have less than the normally required income cash flow or capital to support loan repayments and or already have relatively high debt repayment obligations  Packaging many individual high-risk loans into a much larger package of high risk loans is not diversification in this sense since it is packaging very similar and highly correlated high risk assets  Banks borrowed large amounts of money to lend to consumers and businesses. They then packaged these loans and sold them to other investors and financial institutions instead of originating and holding the loans  There are t least five important types of ethics issues that are structurally related to the above types of finance capitalism 1. Harm to others 2. Leverage proportionality and prudence 3. Moral hazard 4. Transparency 5. Social control and regulation  There is less consensus about how much of the harm was due to the more or less normal cyclical excesses within the financial system and how much was caused by structural problems with the high-leverage finance capitalism system considered above  High unemployment benefits help moderate downward swings in consumption due to unemployment  In addition to high unemployment numbers total debt levels have also increased  There is even some evidence to suggest that the solution to the subprime consumer and subprime corporate debt bubbles has been the creation of a government debt bubble. Debt bubbles can hinder future economic growth and increase risk of another round of deleveraging of debt  The unequal distribution of income in the US during this period of high leverage finance capitalism is also increase: those with the top 1% of wealth more than doubled their share of national income to 23% of total annual US income  While individual researches differ in the precision of their estimates of these declines, there is little disagreement that the size of the damages is enormous  The extent of the bailout measures adopted by various governments
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