Consequences & Actions as a Result of Sub-Prime Lending Crisis

“At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”   – Chairman, Federal Reserve, Ben Bernanke, Congressional testimony, March, 2007  (Read the testimony) 

 

It has been seven years since the problems with the sub-prime mortgage lending started and the Chairman of the Federal Reserve made those comments. Since then, the impact of the subprime market crisis has adversely affected the American society as a whole. On the individual level, homebuyers who were now facing default and foreclosure experienced a number of stress-related symptoms, including anxiety, depression and physical health problems. (Houle and Light, 2014). Researchers Houle and Light (2014) report a direct “association between the total foreclosure rate and overall suicide rates” (p. 1075). On the corporate level, large corporate investment banks that were betting on the subprime mortgage securities were filing for bankruptcy.

Other consequences as a result of the sub-prime mortgage crisis include:

•  American economy has suffered significantly, with the U. S. dollar declining.
• Large investment banks announced record losses due to mortgage-backed assets. In March 2008, the banking industry reported approximately $150 billion in written-off loans. (Santos, 2008).
• Substantial increase in mortgage defaults and bankruptcy.
• 1 in every 171 homes was foreclosed in 2008, up 121% from 2007 (Santos, 2008)
• Neighborhoods and surrounding homes have seen property values decline as a result of abandoned and foreclosed property.
• Insurance companies “have been forces to bear the brunt of the cost” when properties are abandoned, vandalized and damaged.
• Sub-prime lenders have out of business.
• Desperate homeowners resorted to criminal behavior such as arson to rid themselves of a home the banks were trying to foreclose.
• Number of suicides in the United States increased nearly 30% from 1999 to 2010 (Houle and Light, 2014).

Some of the actions that have resulted include:

• In 2008, Congress passed a housing bill to stabilize the housing market and to help homeowners avoid foreclosure (Santos, 2008).
• Some lenders offered loan modifications and refinancing in an effort to avoid foreclosure, but not all.
• Lawyers continue to battle it out in court, bankruptcy lawyers and courts are inundated with cases
• The Housing and Economic Recovery Act and numerous other proposed bills were created to help homeowners.

All of the remedies that were offered were marginal at best. Can a financial crisis like this happen again?  Unfortunately, it is entirely possible if all of the factors fall into place again.

References

Santos, R. (2008). The legal way to defeat optimus sub-prime.   Emory Bankruptcy Developments Journal, 25(1), 285-330.

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

Houle, J. N., & Light, M. T. (2014). The Home Foreclosure Crisis and Rising Suicide Rates, 2005 to 2010. American Journal Of Public Health, 104(6), 1073-1079. doi:10.2105/AJPH.2013.301774

 

 

Social Responsibility & the Sub-Prime Lending Crisis

There are many different participants in the collapse of the housing market and subprime mortgage crisis, including borrowers, mortgage brokers and lenders, investors, securitizers and rating agencies (Gilbert, 2011). However, it is the mortgage brokers and loan officers who are expected to be the experts in assisting and qualifying borrowers. Borrowers, who hoped to get a low-interest home loan, simply followed the rules and guidelines that were explained to them by their loan officer and mortgage lender. Thus, we will focus on the unethical practices of those responsible for targeting sub-prime borrowers.

Although there are many ways to define social responsibility, management expert Peter Drucker (http://www.druckerinstitute.com/link/about-peter-drucker/) wrote, “Every organization must assume full responsibility for its impact on employees, environment, customers, and whomever and whatever it touches. That is social responsibility” (Cohen, 2009).

Company policy-makers have a duty to their company and its stakeholders, but it appears in the mortgage industry there is no consideration or duty towards the borrowers (Gilbert, 2011). Once the loan paperwork was signed, the loan was transferred and the loan officer and broker were paid their commission. Not only did the mortgage industry ignore any kind of sense of duty or loyalty to its customers, they actually went out of their way to target low-income and high-risk borrowers.

The practice of predatory lending became the standard operating procedure, and there was no concern if the customers defaulted on their loan. Gilbert (2011) reports one way to entice low-income borrowers was though no income verification. Applicants stated their income on the application, but there was no verification.

Mian and Sufi (2009) conducted a study of the expansion of mortgage credit to various zip codes across the United States. What they found confirms the theory that mortgage lenders were predatory in their actions. Mortgage lenders targeted subprime borrowers, even though they lived in neighborhoods with declining income growth (Mian & Sufi, 2009).

Morally, lenders and decision-makers had a duty to protect its customers by disapproving loans that they knew would default. The harm that they caused has rippled across the country that is being felt still day.

Next issue:  Consequences and Actions as a Result of Sub-Prime Lending Crisis

 

References

Cohen, W. A. (2009). What Drucker taught us about social responsibility. Leader to Leader, 2009 (51), 29-34.

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

Mian, A., & Sufi, A. (2009). The consequences of mortgage credit expansion: Evidence from the U.S. mortgage default crisis. Quarterly Journal of Economics, 124(4), 1449-1496.

Sharma, S., & Mehta, S. (2012). Where do we go from here? Viewing corporate social responsibility through a sustainability lens. Journal of Contemporary Management Research, 6(2), 69-76.

 

The Shady Business of Sub-Prime Lending

“A lack of oversight has led to a Wild West mentality among unscrupulous leaders, and frankly, the exploitation of large numbers of financially unsophisticated borrowers.” 

– Senator Charles E. Schumer at a Congressional Joint Economic Committee in March 2007. (Langley, 2008)

The banking crisis of 2007-2008, along with the subprime loans, has resulted in the worst housing market collapse in the United States since the Great Depression. This crisis has been the topic of numerous research papers. People want to know how could this happen and who is to blame?

Many feel the blame lies on the financial services industry because of they are easy to target as the bad guy. However, some researchers indicate the crisis was the result of many factors cumulating in the fall rather than a solo factor.

The unraveling of the U.S. economy began with the collapse of the subprime market (Watkins, 2011). Although the term sub-prime loan is frequently used, it might be more appropriate to use the term sub-prime borrowers. Eduardo Pol (2012) explains that sub-prime borrowers are higher risk, they have less collateral and lower credit scores. The subprime borrowers were a relatively untapped market. Lenders offered low interest rates to entice unsophisticated borrowers. However, the teaser rate was simply a bait-and-switch tactic which ultimately led to a significantly higher interest rate. As a result, many borrowers defaulted on their home loan.

About 1.5 million borrowers in 2007 found out the hard way when their lenders started the foreclosure process (Gilbert, 2011), and that number climbed to 2.9 million by 2010 (Houle & Light, 2014). The dream of owning a home was now turning into nightmare for millions of Americans while lenders profited big time.

According to Pol (2012), the rules that governed the banking system not only allowed lenders to participate in risky practices, but the industry seemed to encourage the behavior (Langley, 2008). The cover story in The Banker magazine in 2001, according to Langley (2008), advised mortgage banks to “Find the customers who used to be turned away; by using modern techniques, in credit scoring and securitization, they can be transformed into profitable business” (p. 473).

Bankers turned risky practices into unethical behavior when they started targeting high risk borrowers with complex and creative products. These products were designed to mislead their customers into believing they were getting an affordable loan.

Next blog: Consequences of the unethical leadership decisions that contributed to this crisis.

References

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

Houle, J. N., & Light, M. T. (2014). The Home Foreclosure Crisis and Rising Suicide Rates, 2005 to 2010. American Journal of Public Health, 104(6), 1073-1079.

Kroll, A. (2010). Home Wreckers. Mother Jones, 35(6), 52-57.

Langley, P. (2008). Sub-prime mortgage lending: a cultural economy. Economy and Society. 37:4, 469-494

Pol, E. (2012). The preponderant causes of the USA banking crisis 2007-08. The Journal of Socio-Economics. 41, 519-528

Pollard, L. P. (2013). Treading in high tide: Examining moral hazard within foreclosure reform.  Notre Dame Journal of Law, Ethics & Public Policy, 27585.

Watkins, J. P. (2011). Banking ethics and the Goldman rule. Journal of Economic Issues (M.E. Sharpe Inc.), 45(2), 363-372. doi:10.2753/JEI0021-3624450213