Using Inside Job to Teach Business Ethics

Ernest N. Biktimirov 1 Goodman School of Business Brock University 500 Glenridge Ave St. Catharines, Ontario, Canada, L2S 3A1 e-mail: ebiktimirov@brocku.ca phone: (905) 688-5550 x 3843 fax: (905) 378-5723 Don Cyr Goodman School of Business Brock University 500 Glenridge Ave St. Catharines, Ontario, Canada, L2S 3A1 e-mail: dcyr@brocku.ca phone: (905) 688-5550 x 3136 fax: (905) 378-5723

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

The final publication is available at http://www.springerlink.com/openurl.asp?genre=article&id=doi:10.1007/s10551012-1516-y Citation information: Biktimirov E. N. and D. Cyr. (2013). Using Inside Job to teach business ethics, Journal of Business Ethics 117 (1), 209-219. DOI: 10.1007/s10551-012-1516-y

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Using Inside Job to Teach Business Ethics

Abstract This article recommends the film Inside Job as 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)

Using Inside Job to Teach Business Ethics

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 documentary Inside 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 Job was 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 film Inside 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 3

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 Ross and House of Games to 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 God and The Bank, to stimulate classroom debate in business ethics courses. Most of these films though are based on fictional characters and situations, but the film A Civil Action tells 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 Insider that 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 Street for 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 Money to 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

movie Barbarians 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) for Inside Job. The main focus of this study is to discuss the potential use of Inside Job to 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 film Inside 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

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

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, thenchief 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

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 the Inside 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.

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)

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 mid2010, 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 Job can 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 the Inside Job effect, 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 lowquality 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 film Inside 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 the Inside Job in 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 the Inside Job have 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 film Inside Job has 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 reregulation 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 film Inside 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 for Inside 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 CDOs and 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 America provides 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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