Are subprime loans an unethical financial instrument, or are they ethical but misused in a way that created ethical issues?
Subprime loans are not considered to be an unethical financial instrument. However, their misuse results in both ethical and legal issues. Original goal of subprime lending is helping borrowers with low credit ratings or those who cannot maintain their repayment schedule to receive loans at a rate above prime loans.
Subprime loans appeared in 1970s, when social activists mobilized President Administration and U.S. Congress to deal with social injustices in home ownership, and provide loan opportunities to people from low-income neighborhoods (Eastburn 14). Since then lenders could charge higher rates to this kind of borrowers due to added risk, and make loans to people with unstable credit and employment history, or low incomes. In other words, those who could not qualify for underwriting mortgage loans.
Nonetheless, over time good intentions behind subprime lending were forgotten when money and success became the highest priority of mortgage companies. Their lack of morality and ethics resulted in predatory lending practices, liar loans, and fraudulent misrepresentation of the market and credit risk, enhanced by Wall Street appetite for mortgage-backed securities. According to Eastburn, these securities were sold on the secondary market, and made mortgage firms offer more and more loans, seduced by opportunity to reap higher profits. Some loan originators encouraged people who already own a house to take on larger mortgages, even if they were unable to afford it (4). Furthermore, loan makers and real estate agents intentionally misused subprime loans because their commissions did not depend on future circumstances of the borrower, who was misled and could not meet their mortgage payments overtime.
Discuss the ethical issues that caused the downfall of Countrywide Financial.
As Edmund Brown, California Attorney General once said: “Countrywide Financial Corporation’s lending practices turned the American dream into a nightmare for tens of thousands of families by putting them into loans they could not understand or ultimately could not afford.” (Eastburn 15) Between 2002 and 2007, the revenues of Countrywide Financial Corporation jumped from 4.3 billion to 11.4 billion dollars due to their strategy related to subprime mortgages and loans with no down-payments, while the risk of default and foreclosure was carefully hid (Eastburn 8). Their unethical approaches led to legal charges, revealed the misuse of subprime loans, and inevitably resulted in the downfall of Countrywide Financial.
Countrywide Financial Corporation is now officially in the top of liar loan providers (O’Brian). Liar loan borrowers did not provide any information on their income or assets (“Countrywide Financial Case”). They paid higher interest rates and fees, and ultimately could not afford loan payments or refinance their houses due to housing price fall. Investigations showed that 90 percent of liar loan borrowers provided wrong information in their applications in order to qualify for the loan. Possibly employees of Countrywide helped applicants to falsify their information (Ferrel 389).
As of June 30, 2008, according to the case “Department of Legal Affairs (Florida) v. Countrywide Financial Corp. et. al.,” the company was charged of predatory lending practices. Predatory loans are defined as any loan which would be rejected by a borrower in case of full understanding and knowledge of the loan terms and alternatives available. This kind of loans usually involved fraud, deception, and manipulation in order to make a borrower agree to illegal or unethical terms. It was proved that Countrywide Financial failed to follow industry and its own underwriting standards, convinced borrowers to take loans they were unable to afford and pay off (Ferrel 389).
In addition, the company unethically exploited “teaser” rates, which allowed families for a low monthly payment during the first several years. Besides, mortgage underwriters received bonuses for certain volume of approved mortgages (Gershon). According to Securities and Exchange Commission, from 2005 and 2007 the company was intentionally misusing its underwriting guidelines and providing extremely risky loans to achieve higher profits. Additional claims state that in order to maximize profit the company offered subprime loans to borrowers eligible for regular loans (Ferrel 389).
Another unethical issue of Countrywide Financial was connected to its VIP loan program. According to this program, friends of Angelo Mozilo, Chief executive of Countrywide Financial, as well as those, who could help the company through regulatory and legislative matters, such as supporting the subprime market with favorable laws. This misconduct took place in spite of the fact that company’s ethics code did not allow directors or other employees to influence any kind of decisions of government workers by giving or promising favors, money, loan, or even gifts worth hundred dollars or more (Eastburn 14). Thus, many influential people like U.S. Senators, members of Senate Budget and Finance Committees, and Cabinet members received VIP loans from the Countrywide Financial.
How should Bank of America deal with potential ethical and legal misconduct discovered at Countrywide?
Right after Bank of America acquired Countrywide Financial, it started to resolve ethical and legal misconduct of the corporation. They signed an agreement with state attorneys general to settle Countrywide’s lending practices. In addition, they contacted hundred thousand of potentially eligible borrowers, and modified loans of some of them with pay-option mortgages or subprime (Eastburn 15). Even though Bank of America is incapable of helping all the victims of Countrywide Financial, it has to do its best to regain trust, find all employees engaged in unethical practices or illegal misconduct, and punish them according to the law. In addition, clear ethic code and laws of conduct must be developed and discussed within the company in order to prevent unethical or illegal practices from happening in the future.
Management team of Bank of America must develop a new strategy showing that mortgage lending practices are not solely in the interest of company’s long-term financial objectives, but in the best interest of loan receivers and secondary market investors. This mission must be supported by real practices that would protect people from losing their money and homes they cannot afford. Unfortunately, after exploiting the American dream and acting like a mass-production loan factory, Countrywide Financial and all other mortgage companies lost their credibility and trustworthiness (O’Brian).
In conclusion it is important to mention, that Bank of America has its own history of fraud and unethical practices available in the news. For this reason, the main ethical question arises: can business be ethical when billions of dollars are at stake? Massive fraud we are observing in contemporary market economy can be dealt by law and the fear of embarrassment by the media capable of ruining company’s reputation. As a result, legal penalties introduced by the state government, as well as media activities of journalists and television channels will force companies to avoid legal and ethical misconduct.
“Countrywide Financial Case Study.” AFL-CIO America’s Union Movement. 22 Dec. 2010. <http://www.aflcio.org/corporatewatch/paywatch/retirementsecurity/case_countrywide.cfm>
Eastburn, Ronald W. “Countrywide Financial Corporation and the Subprime Mortgage Debacle”. Case Western Reserve University. 22 Dec. 2010. <https://www.salemstate.edu/search/?cx=011650682194731365967%3Aamrnu76z2bw&cof=FORID%3A10&ie=UTF-8&q=countrywide+debacle&sa.x=0&sa.y=0&sa=Search>
Ferrel, O. C., and John Fraedrich. Business Ethics 2009 Update: Ethical Decision Making and Cases. 7th ed. South-Western College Pub, 2009.
Gershon, Eric. “Countrywide Financial Issues Checks in Subprime Mortgage Settlement.” 16 Feb. 2010. Hartford Courant. 22 Dec. 2010. <http://articles.courant.com/2010-02-16/business/hc-blumenthal-countrywide.artfeb16_1_countrywide-attorney-general-richard-blumenthal-payments>
O’Brian, Gael. Countrywide: How Artificial Reality Trumped Leadership. 21 Oct. 2010. Business Ethics: The Magazine of Corporate Responsibility. 22 Dec. 2010. <http://business-ethics.com/2010/10/31/1739-countrywide-financial-how-artificial-reality-trumped-leadership/>