“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.
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
Ethics and Housing Crisis 