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Ethical Issues with Subprime Loans

A blog aimed at allowing participants to interpret ethical issues surrounding subprime loans.

The Concept of Subprime Loans and the Risks Posed to the Lender & Borrower

“The term subprime (also called nonconforming or non-standard) defines a specific lending market sector where borrowers are considered as posing a higher than standard credit risk (as revealed, for example, by their credit history) and that do not qualify therefore for the prime market.” (Turano, 2006)
Risks involved with the approval of subprime loans to lenders and borrowers were direct and catastrophic in their scope. Not only were the risks felt by borrowers and lenders alike, but the entire economic stability of the United States suffered shock waves that reverberate to modern day.
Borrowers endured through foreclosures that struck across the entire financial spectrum but the misery was felt primarily in the housing market. Additionally, those individuals with a mortgage foreclosure were also faced with the very real probability of having to file personal bankruptcies and remediating the negative effects to their credit ratings and the ability to borrow money in the future. Lenders laid-off thousands of employees and took massive write-offs of their sub-prime assets (homes & commercial properties).
To discuss the risks involved with subprime loans and the resulting financial crisis, it would be sophomoric to not discuss the combined responsibilities of the borrowers, mortgage brokers and lenders, securitizers, rating agencies, and investors. While the intent of regulators was to relax qualification standards, focused at low-wage earners, to afford them the opportunity to participate in the American dream of home ownership, the lack of reasonable consideration to approvals placed an inevitable anvil that dropped the financial markets into a crevasse yet to be fully reversed. “There are many benefits to society of increasing home ownership as long as the financing mechanisms are appropriate. Home owners build equity, take better care of their homes, and participate more in their communities.” (Gilbert, J., 2011)
A compounding, and secondary effect, was felt by borrowers and lenders when it was discovered that secondary and third-market buyers of these assets had been duped by the loan originators, who falsely elevated the asset values to make the bundled loans appear more valuable.

Reference:
Gilbert, J., (2011), Moral Duties in Business and Their Societal Impacts: The Case of the
Subprime Lending Mess, Business & Society Review (00453609), 116(1), 87-107,
doi:10.1111/j.1467-8594.2011.00378, x
Turano, E., (2006), Subprime mortgage lending: recognizing its potential and managing its risks,
Housing Finance International, 21(1), 37-42

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Measures Taken to Prevent another Financial Crisis

Due to the catastrophic effects on the economic stability of the United States due to the subprime loan crisis, new rules were implemented to prevent a similar financial crisis in the future. “The aim of the new regulations, usually referred to as Basle III, was to promote the resilience of the banking industry and improve its ability to absorb shocks arising from financial or economic crisis.” (Paulet, E., Parnaudeau, M., & Relano, F., (2015)
Most financial institutions have adapted their business practices to reflect a more socially and morally ethical approach to all business operations. These adaptations include increased transparency, accountability, and a greater focus on the “common good” of all interested parties. This evolving of business practices has come about because of the expectation by the public that corporations should act in a responsible manner.
The various incarnations of the financial industry have taken different approaches to addressing corrective actions and preventative policies to stave off the impact of future strains on the banking industry. Conventional banking institutions have taken a more cautious approach to lending practices by scrutinizing loan applications with the focus of minimizing negative impact to both the borrower and lender. Conversely, “ethical” banks not only take into consideration the negative impact of a financial crisis when approving financial transactions but mainly focus on business at the local levels.
Additionally, federal regulators have implemented corporate Codes of Ethics that affect all financial transactions and laws like the Sarbanes-Oxley Act, which requires corporations to engage in transparent financial transactions and notifications to all interested parties. While all the policy changes in the world can address specific issues relating to unethical business practices, a corporation has to decide to be socially responsible if newly enacted changes in the laws are to be beneficial to the overall process. Moral people do moral things for moral reasons.
Reference:
Paulet, E., Parnaudeau, M., & Relano, F., (2015), Banking with Ethics: Strategic Moves and
Structural Changes of the Banking Industry in the Aftermath of the Subprime Mortgage
Crisis, Journal of Business Ethics, 131(1), 199-207, doi:10.1007/s10551-014-2274-9

The Role of Leadership Decision-Making in the Subprime Loan Financial Crisis

 

The Role of Leadership Decision-Making in the Subprime Loan Financial Crisis
“The official explanation of the crisis provided by public institutions is that the problem originates in the inappropriate behavior of economic agents, such as selfishness, greed, speculation and in the market inability to function smoothly in order to ensure adequate allocation of resources.” (Radu, C. F., 2011) The crisis originated due to the relaxing of qualification standards by the banking and regulatory agencies responsible for prudent financial policies for the entire economic well-being of the country.
To make the situation even worse, after the regulators and lenders colluded to relax the standards required to qualify for a mortgage, the Federal Reserve raised the interest rate on housing loans significantly. Some predatory lenders preyed upon the naivety of individual borrowers by maximizing the base rate to as much as 18% over the prime lending rate. The direct result of this increase in the interest rates was to make these already fragile loans even riper for default and ultimate foreclosure.
To gain a clearer understanding of the decision-making process that was utilized to initially create the subprime market, it is crucial to understand that financial and governmental entities outwardly portray their intention to assist “main street” while secretly harboring a questionable moral and ethical code. The decision makers knew the risk of approving “zero down” loans to low-income individuals who were not required to even have tangible collateral to protect the loans.
“Corporate and financial misconduct amidst the recent world financial crises, such as the predatory subprime lending practices of Ameriquest, Goldman Sachs, and IndyMac Bank, have left few wondering whether ethics in leadership should be of greater focus moving forward”. (Thiel, C., Bagdasarov, Z., Harkrider, L., Johnson, J., & Mumford, M., 2012)
The only viably sound critique, that can be made, for the leadership decision-making process that resulted in the subprime financial crisis, is that regulators and administration officials were remiss in their fiduciary responsibility to protect the borrowers and lenders, alike. Additionally, the continued disregard for sound financial stewardship and a socially responsible policy of protecting the consumer was instrumental to compounding the financial meltdown for all involved parties.

Reference:
Radu, C. F., (2011), Aspects Concerning the Current Crisis, Scientific Journal of Humanistic
Studies, 3(5), 151-154
Thiel, C., Bagdasarov, Z., Harkrider, L., Johnson, J., & Mumford, M., (2012), Leader Ethical
Decision-Making in Organizations: Strategies for Sense-making, Journal of Business Ethics,  107(1), 49-64, doi:10.1007/s10551-012-1299-1

Subprime Loans & the Notion of Social Responsibility

“A corporation is generally encouraged to adopt CSR because of its perceived benefits to both macro and micro-performances. Macro-performance includes environmental improvement and reduction in social inequality. Micro-performance includes reputation enhancement, potential to charge a premium price for products as well as the enhanced ability to recruit and to retain high-quality workers.” (Wu, M., & Shen, C., 2013)
Corporate Social Responsibility (CSR) is often in conflict with the other primary and crucial responsibility of management to increase profits for stakeholders. Fortunately, the financial rewards for a sound policy of corporate social responsibility often outweigh the costs and expense of developing and implementing the policy. The ultimate goal of a socially responsible organization is to proceed with policies and operations that will result in a win-win scenario for all involved parties, including consumers of the goods and/or services provided.
A socially responsible and healthy banking industry is crucial to economic prosperity. Banks hold and must maintain a measure of public trust that can never become dubious in intent or catastrophic in action. The banking sector acts as the go-between, for the majority of monetary transactions between individuals and corporations, and as such, is expected to be beyond reproach.
An additional consideration that must be factored into the special relationship between the banks and the general public, and whether or not the bank will choose to engage in a sound socially responsible philosophy, is the base fact that the banking institutions “borrow” the assets of their account holders and corporate partners to not only generate positive economic conditions but also to make money for their institutions as well.

This particular aspect of how the banks generate economic activity and increased profitability is the foundation upon which a corporate philosophy of transparency, expediency, and communication must be built to insure all involved parties are being appropriately responded to and responsibly considered.
The pains of developing a social responsible corporate strategy can be minimized by conducting all phases of business operations and activities with the benefits to society as the main focus because studies have shown and the results have proven that increased profitability is a direct result of customer satisfaction with the corporate environment.

Reference:
Wu, M., & Shen, C., (2013), Corporate social responsibility in the banking industry: Motives and
financial performance, Journal of Banking and Finance, 373529-3547,
doi:10.1016/j.jbankfin.2013.04.023

 

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