Measures taken to prevent another subprime crisis

In the time since the subprime crisis very little proactive efforts have been presented to preclude another recurrence.  Granted, there has been an investigation, hearings held to levy blame, monetary restitution promised, and help restructuring homeowners loans.  These are all actions forced on the lending institutions but there is no word what the institutions are doing internally to prevent another crisis.  That is the real concern.

The Justice Department pointed fingers at the worst abusers such as Bank of America, JP Morgan Chase, and Citigroup.  A $25 billion deal was brokered to provide help for borrowers facing foreclosure although for those whose homes were already foreclosed, all they would receive was $2,000 (Fox News Politics).  An Independent Foreclosure Review was established to, “give the homeowners an opportunity to have an unbiased third-party review their foreclosure” (Hallman, HuffPost, 01/10/2013).

The above actions are all well and good, however, considering the lack of ethical and moral fortitude by lenders in the past, I’m skeptical.  Even more ominous is the fact the Independent Foreclosure Review has been scrapped and, basically the homeowners are to work with the very lenders who led them astray from the start (Hallman, HuffPost, 01/10/2013).

In my research, no information was found describing what these lending leaders are doing to shore up the  ethical and moral standards of their institutions.   They had policies and standards in the past but they were not applied and a faulty standard became ingrained.  This should not be allowed to happen.

 

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Subprime loans and social responsibility

Subprime loans represent the worst in business social responsibility and led to the recession that began in 2007.  The decisions made by individual lending officers and brokers substantially contributed to the failure of numerous lending institutions and cost many of the populace to lose homes.  The officials handling these loans had a moral obligation and an ethical duty to the customer and the institution to be open, forthright, and honest.  Instead, many decided to engage in predatory and careless lending (Gilbert, p.88-89).

The many disconnects in the mortgage lending business are complex and convoluted.  No longer does the mortgage holder keep the mortgage in the local institution for the life of the loan, rather the loans are bundled together and sold to investors thus severing the personal connection at the local level.  Further, a loosening of underwriting standards removed the burden of accurate computations from the underwriter.  When the loans were bundled and sold, the risks were passed along to the purchaser, essentially absolving the underwriter from all repercussions.

This is the ultimate repudiation of social responsibility.  The discretionary decisions made by front line lending and underwriting personnel were not questioned as the profits were so phenomenal based on an incredible “increase in home values of 124 percent between 1997 and 2006” (Bianco, p.6).  There was little to no information integration, forecasting of future outcomes, or questioning the ethical and moral principles of subprime loans (Thiel, p.56-58).  It was rather stand-fast, hold your position, and follow the Goldman Rule (Thiel, p.63-66).

 

 

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Leadership role in decision-making in the subprime loan crisis

Lending continuum

Prime (green)  ➯➯                       Alt A / ARM (yellow) ➯➯                    Subprime (red)                  
– Excellent credit history             – Clean credit history                        – Blemished credit history

– Verified sufficient income        – Lower income                                  – Little to no verification of income

– Well documented papers         – Less documentation                     – Little to no documents

– No risk                                            – High risk                                             – Highest risk

Looking at the lending continuum chart above and the probability of high risk with subprime loans, it is incomprehensible that leadership would decide to target this group to enlarge the company’s coffers.  The reason can be directed at several general principles.  First is the Goldman Rule to “pursue profitable opportunities regardless the effect on others”  (Watkins, p. 363).  Second is the culture in the financial world.  As Milton Friedman pointed out, the responsibility of business is to increase profits (Friedman, p. 1).  Third is the philosophy of “caveat emptor” or let the buyer beware.  In other words, it is not the place of the lender to tell or explain the nuances of the loan, rather the borrower is the one responsible to know what can happen if the situation changes in the future.  Last is greed, a disease that permeates the halls of financial institutions and produces symptoms such as ultra-competiveness; one-upmanship; lax or lack of ethics behavior and/or social responsibility (Watkins, p.364).  That is not to say all leaders are painted with the same brush, however, most did very little to curtail employees’ actions.

Theil, Bagdasarov, Harkrider, Johnson, and Mumford espoused, “Government and public officials including the Securities and Exchange Commission and the United States Senate have questioned leaders over their dubious and, seemingly, misguided decision-making,” and, “wonder how such misconduct could occur even when organizational policies and guidelines exist to safeguard against unethical practices” (Thiel et al, p. 49).

President Obama stated in 2012 the housing bubble contributed to the subprime housing market and asserted the financial leaders, “were plainly irresponsible,”  and had exhibited, “servicer misconduct” (Fox News Politics, 2012).  It is still not clear the extent of top leadership’s knowledge of the subprime situation but there is no doubt they knew of the tremendous profits being made.  Lower level brokers and lenders, the securitizers that bundled the loans, and rating agencies that overvalued the loans are all complicit in the subprime crisis.  Even the borrowers were complicit as many lied on applications and “fudged” on their stated income (Gilbert, p.91).

With this many people on the front end of the mortgage process, all looking for a good deal of one kind or another, the opportunity to make unethical and morally unsound decisions was strong–the resulting consequences were dire.

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Subprime loans: Risk to the lenders and borrowers

The subprime lending crisis that occurred in the United States around 2006 is unique in history as the first time a plunge in the overall economy was driven by a credit crunch in the non-banking sector of finance (Bianco, p. 3).  A new, specialized, unregulated, mortgage lender emerged offering high-risk loans and incentives for buyers.  ARMS, or adjustable rate mortgages, offered “teaser rates” that were very low, temporary introductory rates that would sometimes double the monthly mortgage payments after the initial period was over.  Interest-only loans came with the teaser to pay only the lower interest vice any payment on the principle.  The lenders also institutes “no doc” and electronically-processed/signed loans mitigating any need to verify income-to-debt ratio on loan applications.  These and other lax standards, coupled with the overvalued, unsustainable housing market led the housing bubble to burst.  Once the housing market made a correction and the valuation of housing dropped as much as 50 percent (Bianco, p. 6), the subprime mortgage industry collapsed causing multitudes of home foreclosures.

Why a borrower would take out such a loan is easy to understand–temptation.  The lures of teaser raters and incentives appeared to be a “Golden Opportunity” and the adjustments upward could be ignored as that would not happen until in the future.  Why the lender would offer such teasers and incentives is also easy to understand–the enormous profits (Watkins, p. 366).  With little thought regarding long-term consequences of subprime loans, both the lender and the borrower inked the loan setting up a formula for disaster (Bianco, p. 2-8).

The consequences resulting from the subprime lending were enormous and wide-spread.  People were defaulting on loans and mortgage lenders were foreclosing.  People had to vacate the homes and leave them empty.  The lenders who foreclosed were ill-prepared to maintain the homes thus making the situation ripe for squatters to move in and cause damage.  The lawns became ragged and overgrown impacting not only the value of the foreclosed home but also the value of homes throughout the neighborhood.  This was not an isolated incident as many homes were being foreclosed throughout the country causing even more devaluation of homes.

As the situation worsened, financial leaders tightened loan requirements thus causing more borrowers to be unable to qualify for loans for a house or to build one.  With fewer loans approved, home builders, carpenters, electricians, pipe fitters,  carpet installers, and a host of others found their incomes constrained.  Realtors and closing agents also felt the impact as the market declined.  The lenders experienced layoffs, bankruptcies, and the loss of hundreds of billions of investment dollars (Gilbert, p. 89).  The downfall of subprime  mortgage lending, coupled with the housing devaluation from the market correction, made some homes worth less than the loan on them.

The above are the risks the lenders and borrowers each willingly accepted at the beginning.  In the end, it took “injections of money and reduction of interest rates by the Federal Reserve Bank ” (Gilbert, p. 89) and help from the Federal government to stabilize the situation, albeit slowly.

The leadership role in this debacle needs examining.

 

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