Subprime loans: Social responsibility and the consequences

In this final part 3 of 3, I will discuss the social responsibility or lack thereof of subprime mortgages lenders. In previous part 1 of 3 of the blog I summarized the subprime mortgage mess and in part 2 of 3 blog I discussed the role that leadership decision making played in the subprime mortgage fiasco.

When mortgage lenders agreed to give mortgages to borrowers who could not pay back they failed to act in a social responsible manner. Gilbert (2011) argues that setting a policy that could lead to defaults and probably cause harm to both the borrower and lenders; even though the mortgage broker and the bank were compensated when the loan was funded and then sold to a securitizer is socially irresponsible. Individuals employed by a company have certain moral responsibilities borne from holding those positions and some of the decisions they have to make have ethical dimensions, ignoring this aspect is in fact a moral failing on their part (Gilbert, 2011).

According to Watkins (2011), individuals and organizations that believe in Laissez-faire polices may pursue monetary values without moderation. Furthermore, for individuals without ethical reflection there is no compromise, but a single minded pursuit of profit. Individuals and organizations will more likely engage in behavior that disregards the broader consequences, the more rewarding the opportunity is. According to Watkins (2011), this is exactly what happened with the subprime mortgage mess.

Subprime lenders did not care about for social consequences just profit. Gilbert (2011) cites an employee of one of subprime lenders as saying that the finance companies targeted blue collar workers, individuals with no college education, older folks on fixed income, foreigners who did not speak English and individuals with significant value in their homes. A borrower had her mortgaged refinanced or flipped seven time in a two year period, increasing her home equity loan by over $52000, while she receiving less than a $100 in cash. Gilbert (2001) cites a June 2008 Newsweek article that wrote how a mortgage broker in Cleveland, brokered 71 mortgages in one area during the period 2003 to 2006. All these mortgages were foreclosed in the next two years, leaving behind a blighted neighborhood, riddled by crime and lost home values.

It would not suffice here if Goldman Sachs’ (a leader in Wall Street investment banking) role in the subprime lending goes unmentioned. According to Watkins (2011), Goldman Sachs securitized the subprime mortgages and sold them to unwary investors with the willful knowledge that the investments were designed to lose value, as claimed by the Securities and Exchange Commission. Watkins (2011) refers to Goldman Sachs behavior of engaging in ethically controversial behavior as the Goldman Rule. Goldman Sachs convinced American International Group (AIG) to sell them credit default swaps, which earned Goldman a $14 billion dollar profit leaving the U.S. taxpayers with the bill.

                     What’s to stop this from happening again?

       The U.S. government bailout the financial institutions that were distressed by the financial crises when President George Bush signed the Emergency Economic stabilization Act of 2008 (Bayazitova & Shivdasani, 2012) which established the Troubled Asset Relief Program (TARP).The  Capital Purchase Program (CPP) announced later allowed U.S. financial institution to apply for preferred stock investment from the U.S. treasury. The American Recovery and Reinvestment Act of 2009, was signed by President Barack Obama and it included a number of spending measures and tax cuts to help spur economic recovery (Bayazitova & Shivdasani, 2012). Further, the U.S. congress passed House Rule (H.R.) 1586 that imposed a punitive 90% excise tax on employee bonus pay for financial institutions that received TARP funds.

According to Watkins (2011), the Basel III accord was signed in December of 2010 in Switzerland, as a measure to avoid future financial crises. The proposed regulation raises capital requirements for banks. The regulation seeks to control the ability of banks to leverage capital, the logic here being that larger capital requirements would provide greater insurance against future losses. Critics are doubtful whether the requirements are sufficient to avoid future crises. One of the criticisms for Basel III is that banks have until 2019 to comply and it does not address the issue of the too big to fail banks. Furthermore, Basel III does not constrain bank activities nor does it address their social responsibility. Finally institutional structures existing before the financial crises are left intact according to Damian and David (as cited by Watkins, 2011).Basel III was revised in January 2013 to improve the provision regarding the size, make up, and accessibility of liquidity buffers ( Kowalik, 2013).The new revision allowed financial institutions to use the liquidity buffer if needed among other changes.

References

Bayazitova, D., & Shivdasani, A. (2012). Assessing TARP. Review of Financial Studies, 25(2), 377-407.

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

Kowalik, M. (2013). Basel Liquidity Regulation: Was It Improved with the 2013 Revisions? Economic Review (01612387), 65-87.

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

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

Muller-Kahle,M.I & Lewellyn, K.B.( 2011). Did board configuration matter? The case of US subprime lenders. Corporate Governance: An International Review, 19(5): 405–417