Subprime Loans: The Under-the-Radar Loans that Felled a Market – Part 3

Measures to Prevent Reoccurrence

This final blog will view the measures of prevention of a reoccurrence of the subprime mortgage crisis, while utilizing John Watkins’ article entitled “Banking Ethics and the Goldman Rule”. Financial institutions are viewed by most people as a wealth creator, a place to go to cash their paychecks and to borrow money. Watkins (2011) state that “many financial institutions engage in unscrupulous actions to convert household wealth into corporate profits” (p. 363). “Subprime mortgages offered an opportunity to tap into a new source of profits and banks pursued subprime loans to tap into a new source of income without any regards to the effects such loans may have on borrowers” (Watkins, 2011, p. 363).

Litan (2009) characterize subprime borrowers as less sophisticated or knowledgeable in the area of finance than prime borrowers and says “they have been easier prey for unscrupulous lenders who have engaged or victim of “predatory lending” schemes (p. 7). Jeffee and Quigley (2008) state that the “Federal Housing Administration or FHA explicit policies designed to protect potential homebuyers better from their own financial illiteracy and from unscrupulous ‘predatory’ lenders” (p. 118). Today, the FHA is viewed as the primary mechanism through which the government provides aid to defaulting subprime borrowers in order to avoid foreclosures on their mortgages (Jeffee and Quigley, 2008, p. 138).

According to the China.org.cn (2008) website “Most analysts link the current financial crisis to the sub-prime mortgage business, in which US banks gave high-risk loans to people with poor credit histories.” Subprime and other types of loans, bonds and/or assets are bundled into portfolios called Collateralized Debt Obligations or CDOs and sold on to investors globally. The impact of the sub-prime mortgage crisis quickly made itself felt beyond the United States” (www.china.org.cn). This is illustrated in the graph below:

                

The subprime lending crisis provides strong messages for the financial institutions, government, lending agencies, and borrowers. It is very important that the borrower know the facts of disclosure before signing any agreement. Predatory lending should be prohibited and a new reform of mortgage lending implemented to provide safer means when acquiring a home. Make adjustments to the bankruptcy codes and restrict foreclosures.

Subprime Loans: The Under-the-Radar Loans that Felled a Market – Part 2

The Role of Leadership Decision-making

     Part 1 of the blog summarized the Subprime Loan crisis, which began with the unraveling of the U. S. economy, collapse of the market, and the public left in turmoil. But who was responsible for this mess, blame was being tossed amongst the businesses, government, lenders, and borrowers. Gorton (2008) identifies “the defining characteristic of a subprime mortgage as being designed to essentially force a refinancing after two or three years” (p. 12). Lenders are compensated due to the risk involved in obtaining and approving a loan; the risker the better. This part of the blog will focus and examine Thiel, Bagdasarov, Harkrider, Johnson, and Mumford (2012) article entitled “Leader Ethical Decision-Making in Organizations: Strategies for Sensemaking” as a foundation in identifying the role leadership decision-making played in the crisis as well as leader social responsibilities.

     Businesses attempt to safeguard themselves against unethical business practices and behavior by establishing organizational policies and guidelines. Leaders and management, as well as other personnel are expected to behave ethically to uphold good company reputation. Gilbert (2011) acknowledged General Motors CEO, Alfred Sloan’s writing, that stated “An organization does not make decisions; its function is to provide a framework, based upon established criteria, within which decisions can be fashioned in an orderly manner, noting that individuals make the decisions and take responsibility for them” (p. 92). Thiel, Bagdasarov, Harkrider, Johnson, and Mumford (2012) depicts that “Organizational leaders face environmental challenges and pressures that put them under ethical risk” (p. 49).

     Thiel et al. (2012) characterize leaders as having less integrity with a prone of behaving unethically and proposes four trainable, compensatory strategies of ratifications: 1) regulating emotions; 2) self-reflection; 3) forecasting; and 4) information integration as great ingredients which facilitate and aid leaders in navigating ethical dilemmas in organizations while obtaining the possibility of reaching an ethical decision (p. 49). Watkins (2011) state “the greater the profitable opportunities the more likely individuals and organizations will engage in behavior without regards for broader consequences” and that “securitizing loans and passing them off at the risk of others provide even greater temptations (p. 365).

Subprime Loans: The Under-the-Radar Loans that Felled a Market – Part 1

The Case of Subprime Lending

Ethical violations in finance such as insider trading, campaign financing, corruption, fraudulent financial dealings, and larceny are only a few examples of the unrelenting ongoing necessity to manage, regulate, and promulgate ethical conduct at the individual, corporate, and government levels. In 2002 in an effort to regain public trust and loyalty, the Sarbanes-Oxley Act was established to restore the integrity and confidence within the financial markets. This blog consists of a three-part summary detailing the subprime loans crisis while ascertaining its social responsibility, leadership decision-making, and measures undertaken in preventing recurrent conditions of market failure. The first blog will focus and examine the article of Joseph Gilbert (2011) entitled “Moral Duties in Business and Their Societal Impacts: The Case of the Subprime Lending Mess”. Subprime loans are loans that were offered to borrowers whose credit scores were below the acceptable rating of 570. Gilbert (2011) quoted Investopedia’s definition of a subprime loan as “A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans” (p. 89).

By the end of 2006, the Federal Reserve had reported that 2.1 percent of residential mortgage loans held by banks were delinquent. The American dream became an American nightmare for thousands of homeowners; when they found themselves no longer able to afford the high interest rates contracted with Subprime mortgage; they eventually became delinquent on their payments, lost their homes to foreclosure, and for some personal bankruptcy which sequentially caused the mortgage market to drop (Gary, 2007, p. 1). Subprime mortgages was held accountable for half of the less than 20 percent of the 1.5 million homeowners in the United States that initiated foreclosure proceedings in 2007 (Gilbert, 2011, p. 88). The accelerated number of foreclosures created chaos within the housing market, banking industries, and the credit market. The stock market declined, the credit market froze, and the global money markets became unstable. The event caused tens of thousands to be laid-off and consumer debt to skyrocket into billions.