The Financial Numbers Game | Charles W. Mulford

Summary of: The Financial Numbers Game: Detecting Creative Accounting Practices
By: Charles W. Mulford


Dive into the eye-opening world of creative accounting practices and their impact on the economy with ‘The Financial Numbers Game’ by Charles W. Mulford. The book summary delves into six significant ’causes, consequences, and cures’ that shaped the financial crisis, exploring the intricate relationship between capitalism, business cycles, and government policies. Gain a deeper understanding of how the Federal Reserve, U.S. Treasury Department, and federal agencies contributed to the 2008 crisis, the role of housing and banking sectors, and the importance of adopting a free-market capitalist approach to prevent future economic disasters. This summary will guide you through the critical topics and themes, unravelling complex notions using an engaging and user-friendly language.

The Untold Causes of The Great Recession

The Great Recession has been widely attributed to Wall Street greed and capitalism. However, the reality is far more complex, and irrational government policies are to be blamed for the financial crisis. The book presents six “causes, consequences, and cures” that are often overlooked in analyzing the crisis. These key factors include the US government’s role in the housing industry, the Fed’s poorly executed monetary policies, and the exclusion of nonbank financial institutions from regulation. The book sheds light on the root causes of the Great Recession and offers solutions to prevent such crises from happening in the future.

Capitalism and the 2008 Crisis

Capitalism, with its business cycles of booms and busts, is considered flawed by many due to the government’s need to step in and regulate markets. However, the 2008 financial crisis showed that the government itself had a hand in creating the risk that led to the crisis. Contrary to popular belief, deregulation was not the cause of the crisis. Instead, regulatory burdens from major laws, such as the Sarbanes-Oxley Act and the Patriot Act, piled up and added billions of dollars to audit and financial security expenses. Privacy Act disclosure notices also cost hundreds of millions of dollars annually. The financial industry’s cost of regulation spiked in the years leading up to the crisis, signaling that government intervention can also lead to distortions in the market.

The Rise and Fall of the American Dream

The American Dream of homeownership was incentivized by the government through financial enticements and programs that extended loans to minorities. However, the overallocation of capital in the housing market created a bubble. In 2006 and 2007, the new Fed chairman increased the Fed Funds rate, ending the dynamic that both Alan Greenspan and stakeholders viewed as a no-lose scenario. The colossal portfolio amassed by the GSEs peaked in 2008, with $2 trillion in subprime mortgages and 1,000 to 1 leverage.

The 2008 Financial Crisis: A Result of Poor Governance and Risky Behavior

The banking sector plays a critical role in providing capital and liquidity that drive the economy forward. However, misguided policies and risky behavior led to the subprime meltdown, causing a liquidity crisis that triggered the 2008 financial crisis. Financial institutions took in funds from depositors and lent them out to companies, projects, and assets, making profits through leverage. But, too many banks piled enormous debt into their balance sheets, and investment banks’ pre-crisis leverage ratios stood at approximately 30 to 1. The Federal Deposit Insurance Corporation (FDIC) was created to protect depositors’ funds, but it allowed perils to develop and compromised the health and quality of financial institutions, rewarding risky behavior. The FDIC exercised shoddy governance over the financial industry, cementing the belief that the government would be the last-resort rescuer of banks deemed “too big to fail.” The 2008 crisis was triggered by a complete washout of capital – $500 billion – due to misallocation of capital into residential housing in prior years. Housing prices were 30% higher than people could afford, leading to a subprime meltdown. Stakeholders didn’t recognize the potential danger of residential housing assets, treating them as investments instead of consumption. The securities that institutional investors had purchased contained huge amounts of toxic subprime paper with a premium-grade seal of approval from the rating agencies. The agencies’ mathematical models failed, and the damage from the ratings fiasco affected the wider capital markets. Regulators labeled financial firms outside the traditional deposit-based monetary system as “shadow banking” entities, consisting of hedge funds, insurers, the investment banking community, and more. Unregulated, these firms dealt with innovative derivatives that proliferated based on the assurance of premium grades from rating agencies. Incentives from government regulatory policies encouraged most financial institutions to make the same mistake.

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