The Subprime Mortgage Lending Crisis

The Concept of Sub-Prime Lending

subprime-scoresSubprime lending began when banking leaders realized that there were substantial financial benefits to lending to an untapped market of low credit scoring customers, or consumers looking to gain the monies from the equity of their pricey homes.  By definition, subprime lending is the offering of higher or variable rates to borrowers that do not qualify or even have the means to pay, when or if circumstances change (Gilbert, 2011).

During the height of the housing boom, financial organizations started to lend to individuals without the standards that were used in the past.  Banks are in the business of paying and selling debt (Angel, 2016).  Therefore, many banks took on the risk of subprime loans with the notion of selling them quickly to other institutions.  These other financial institutions were not as heavily regulated or even had underwriters that did not closely review loan documents and consequently more loans were approved, bought and sold.  However, as borrowers stopped paying their mortgages and began to go into default, abandoning their homes, the banks and other lending bodies started to feel the effects of their actions. This lead to the mortgage crisis that hit the United States in 2008-2009, and was a blow to financial institutions across the country.  However, conceivable it was one that they brought on themselves and one that perhaps could have been avoided (Gilbert, 2011).

The Risks

There were risks involved with subprime lending practices, to not only the lender but the borrower as well.  Borrowers of subprime loans were lured in by an interest rate that would enviably be adjusted to a higher rate, and would prove to be nearly impossible to pay.  Other borrowers did not have the credit knowledge, financial knowledge or wherewithal to understand the effects of a variable rate mortgage and how drastically payments could change over time.  This meant that the borrower’s homes became unaffordable and many quickly lost their homes.  As consumers began to leave their homes the housing prices in affected areas dropped drastically.  While the subprime crisis was complex, it is quite clear that the risks outweighed the benefits of financial gain banking institutions had expected.  According to Gilbert (2014), the risks were substantial and included the following:

  1. riskHigh number of defaulted loans
  2. Increased foreclosures
  3. Borrowers being quickly removed from their homes
  4. Entire neighborhoods being abandoned
  5. Squatters taking residence in abandoned homes
  6. Left behind homeowners questioning the value of their homes in abandoned areas

This was in essence the kick-off of what would be the worst recession in many years and what sealed the fate of the downfall of the global economy.  At the height of this crisis there were more than a million homes in foreclosure.  American banks could no longer sustain debt control and the fallout effected the entire financial market, having a ripple effect across the globe (Gilbert, 2011).

Role of Leadership

While the goal of all companies is to be profitable, it seems that the banking industry has an unhealthy obsession with profitability, at any cost (Cornett, Erhemjamts, & Tehranian, 2016).  Culture plays such a pivotal part of what is viewed as ethical or unethical, and because the banking culture is so unique in that they are in the business of making money from debt, it is even more conceivable that issues may arise (Stephens, Vance, & Pettegrew, 2012).  Thus, it is reasonable to consider that this entire crisis sits on the shoulders of the lending industry leaders that made poor, and perhaps even unethical decisions to gain a profit.  It can be argued that the extreme pressures put on financial leaders caused them to make bad decisions regarding subprime lending.  However, it is the role of the leader to use their ethical decision making tactics to overcome misguided or irresponsible situations (Thiel, Bagdasarov, Harkrider, Johnson, & Mumford, 2012).  With regard to the depth of how many homes were lost and the ultimate downfall of the entire housing industry, is it safe to assume that there was a lack of social responsibility on the part of financial industry leaders?

banking-leaders

Social Responsibility  

It would be quite easy to lay all blame on the financial institution leaders that made the decisions to so thoroughly risk it all for the benefits of subprime lending.  However, there were so many others that had a responsibility to protect the sanctity of the housing industry.  We know that lenders were negligent, but borrowers also played a role in the crisis.  Some borrowers were uninformed or uneducated about the process, however others may have lied on applications get loan approval.  Furthermore, some brokers intentionally did not ask the questions needed to deny loans, as a way around the borrowers lack of credit or income. There were also the rating agencies that boosted credit ratings for consumers in the subprime segment, allowing approvals that would not have happened otherwise.  All of these groups played a role in the crisis.  The downfall could have been prevented if the checks and balances put in place by the industry’s policy and government’s regulations would not have been ignored (Gilbert, 2011).

According to Watkins (2011), banks follow the Goldman Rule, that stats the pursuit of profit matters more than how it effects on others.  This is why ultimately, above any other party involved, banking institutions total lack of regard for the welling being of its customers makes them the greatest offenders.  Furthermore, they only began to care when the negative effects of their actions caused harm to their profits and financial stability (Watkins, 2011).  Subsequently, there was indeed a lack of social responsibility on the part of the banking industry.

Preventative Measures

In the aftermath of the housing and subprime lending crisis, we see many lost jobs, homes and profits. The United States’ economy took a major hit, spinning the country into a deep recession (Gilbert, 2011).  With all of this in mind many measures have been put in place to prevent future situations from occurring.  These measures include stringent credit and loan approval processes enforced by lenders, brokers, raters and government agencies.  It is now more difficult to get a home loan and the requirements are strictly enforced and reviewed by several parties.  Other measures include federal regulations limiting the amount of debt a consumer can have.  The new federal rule known as the ‘ability to pay’ rule, reviews borrowers credit as well as how much current debt they have, meaning that despite an acceptable credit score they may not qualify for a home loan (Bubb, & Krishnamurthy, 2015).

All of these measures together will ensure that another subprime crisis is not experienced.  However, the key is for banks to continue to have good self-regulating practices (Turner, 2012).  Even without governmental regulations, the banking industry should not allow unethical methods to dominate its institutions.  Finally, we see that when a lack of social responsibility is coupled with poor decision making and pure greed, things go awry (Thiel et al. 2012).

References

Angel, J. (2016). On the Ethics of Fractional Reserve Banking. Journal of Competitiveness
Studies, 24(3), 164-176

Bubb, R., & Krishnamurthy, P. (2015). Regulating against Bubbles: How Mortgage Regulation can keep Main Street and Wall Street Safe from Themselves. University of Pennsylvania Law Review, 163(6), 1539-1630.

Cornett, M. M., Erhemjamts, O., & Tehranian, H. (2016). Greed or good deeds: An examination of the relation between corporate social responsibility and the financial performance of U.S. commercial banks around the financial crisis. Journal of Banking and Finance, 70137-159. doi:10.1016/j.jbankfin.2016.04.024

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

Stephens, W., Vance, C. A., & Pettegrew, L. S. (2012). Embracing Ethics And Morality. CPA Journal, 82(1), 16-21.e

Thiel, C., Bagdasarov, Z., Harkrider, L., Johnson, J., & Mumford, M. (2012). Leader Ethical Decision-Making in Organizations: Strategies for Sensemaking. Journal of Business Ethics, 107(1), 49-64. doi:10.1007/s10551-012-1299-1

Turner, A. (2012). Credit creation and social optimality. International Review of Financial
Analysis, 25(Banking and the Economy), 142-153. doi:10.1016/j.irfa.2012.09.004

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

 

Dr. Cassandra Bowers

Future Dr. Bowers
Milwaukee Art Museum

Dr. Cassandra Bowers, or Cassandra Bowers, PhD! Doesn’t that have a nice ring to it? If you ask my uncle, he would tell you that even further back than I can remember, I have always wanted to be a doctor.

So here I am, seven years after getting my Master’s degree, finally working toward my doctorate. I think the ultimate comprise in my childhood dream of working in a doctor’s office is to become a business doctor. It is so very exciting. I am learning so much about my topic (diversity in leadership) and about myself.

Yes, I still work full-time.
Yes, I still am socially active with my family and friends.
Yes, I still relax and have me-time.
It is just now every moment of my day is planned out. It is very rare that I have spontaneous activities. What am I saying? It’s not rare, it never happens.

I dedicate 40-50 hours per week to the work that pays my bills. I am the Director of a college career center. Basically, I help students find internships and employment. It is an extremely challenging but fulfilling job. Imagine helping a student realize their life long goals? Pretty sweet.

My number one focus after work is to get to my parents’ house by 5:30 so that I can have a quick workout and then eat dinner with my family. We eat as a family single every night. I am so completely blessed to have parents that live so close and to have a mom that is willing (and able) to cook for all of us.

When I finally get home around 6:30-ish, I cuddle with my grandson until he falls asleep. Or he decides he would rather cuddle with his mom (sad-face). Then I review my homework, make some notes about my research and watch 30 minutes of a recorded show until I am so sleepy that I can barely keep my eyes open. It’s only 10 o’clock, mind you. Ha-ha.

My weekends are totally dedicated to studying, writing, research and my weekly assignments that are due on Sunday night. Unless I have a pre-planned event to attend, or my other grandson is spending the weekend with me. In that case I work harder during the week to complete my assignment by Friday. My time with my grandsons is so precious to me that I make them a priority as much as I am able.

My me-time comes in the time that I spend in libraries, coffee shops and mall food courts, alone, doing research. I so love research. I go off on these complete tangents about random things that I just have to know more about. Like why we kiss after we say I do, or that we pronounce the “h” in Herbert but not herb. There is also the scholarly research, that I love even more. The things I am discovering about our world, especially the business world, are so fascinating. (I can’t wait to share more about it, stay tuned.) But, I do take breaks, and go to the Art Museum or the movies alone. These 2 hour breaks do wonders for my mental health.

So, that is my little life in a nutshell. Completely filled to the brim more than I ever thought it could be. And beautifully more than I could have ever imagined it would be.