The Subprime Meltdown - Report Example

The Subprime Meltdown Q Are subprime loans an unethical financial instrument, or are they ethical but misused in a way that created ethical issues? A.1. The subprime loan market is concerned with granting of loans to the people at a rate of interest greater than the market rate. Rate of interest charged for the subprime loans offered depend on several factors viz. amount of initial payment given, the ratio of amount of debt and the income level and the payment and credibility position of the individual. However, the process of granting the subprime loans is observed to counter high level of risk. It is because the persons applying for the loans may counter crisis later on for which they can fail to make the payments. The subprime loans are issued for a variety of financial and economic reasons. However, it had earned much publicity owing to its link to the mortgage market. The nature of the subprime loan market shows that the loans are rendered to individuals having considerably lower income levels and thus counters a high level of risk in getting payments. It is further observed that during the period from 2004 to 2006 a majority of the people belonging to middle and higher revenue groups took resort to subprime loans. Moreover, the continuous rise in the price of the property assets triggered high speculative tendency among the investors who increasingly took resort to subprime loans for financing construction schemes. (Fraedrich, Ferrell & Jackson, n.d., p. 385; Weston, 2006) High amount of fraudulent practices had tarnished the mortgage market during the period of 2005 with the total fraudulent amount ranging to $6 billion. Both the borrowers and the lenders have equal hands on the fraudulent activities. The borrowers by concealing required information or by providing erroneous information can help commit fraudulent activities. Similarly the lenders through a network of political parties and other interest groups like lawyers can over appraise the property valuations. (Lander, Barker, Zabelina & Williams, 2009; How do I choose an ethical subprime lender?, n.d.). Further, to judge the ethical nature of the subprime loan market three parameters can be set viz. the level of justice involved, sense of loyalty and the truthfulness of the trade. While reflecting on the criteria of justice it is found that the lenders in the home loan market were more interested in gaining profit and cared less for the borrowing mass. Moreover, the amount of premium adhered to the home loans were of a higher pattern and the information was concealed from the borrowers. This helped the money lenders to gain the maximum profit. Hence, the activity conducted in the home loan market was totally unjust. In the context of loyalty it is observed that the middlemen or brokers involved endeavored to gain from both sides viz. the lenders and borrowers. It is found that the broker charged high levels of interest from both the money lenders and borrowers. Thus, the level of trust involved between the parties also got tarnished owing to the said event. Finally, both the borrowers and lenders carried on the practice of rendering false information regarding the event of higher claims and the scheme of over appraising respectively. Herein, both the parties wanted to get access to higher amounts through the process of misrepresentation which tarnished the quality of truth involved in the trade. (Garcia, Gonzalez, Goroway, Mellis & Sarmiento, n.d.) Hence, it is observed that nature of subprime loans primarily do not reflect unethical behavior. However, the pattern of usage of such loans by the different parties attached to it tarnished its ethical image in a great manner and made it fully unethical in nature. Q.2. Discuss the ethical issues that caused the downfall of Countrywide Financial. A.2. The financial firm Countrywide Financial during the period of 2000 earned high revenues through the subprime loan market. It was observed that during the 2001 period the revenues obtained through the subprime loan market accounted for 28 percent of the total revenues of the firm. Countrywide Financial was observed to take resort to unethical practices while generating loan to the borrowers. It was found that Countrywide Financial rendered subprime loans by force even if the borrowers had applied for a normal loan. Furthermore, the loan generating firm Countrywide Financial became the center of unethical practices for generating loans to borrowers without rendering an eye on the level of income and the amount of property owned by them. Countrywide Financial resorted to this practice for it helped the firm get access to higher income through the charging of higher rates of interest from the ‘risky’ borrowers. However, in the long run with the crash in the housing market owing to soaring interest rates these groups of borrowers failed to repay the loan amount which led to the demise of the company. (Fraedrich, Ferrell & Jackson, n.d., p. 387, 389). Q.3. What was the role of founder and CEO Angelo Mozilo in Countrywide’s demise? A.3. The fall of Countrywide Financial increased the expectations that it was the activities of the founder and the Chief Executive Officer, Angelo Mozilo that had help trigger such an event. It was observed that during the period between 2002 and 2008, Angelo Mozilo had earned $400 million through the sale of stocks. However, Mozilo when interviewed at a later stage declined to such event and desired to create a favorable image for himself. Mozilo’s fraudulent image came to the scene between the periods of 2007 to 2008 when his name came up in a huge number of legal cases. Mozilo was also accused of many fraudulent practices inside the company like maintaining inappropriate accounting records. The large amount of fraudulent practice was conducted by Mozilo to gain access to greater funds which was left unrecorded. Moreover, the staffs of the Countrywide Financial also stated that large number of officers and managers under the direction of the Chief Executive Officer had gained huge amount of revenue around $848 million through the sale of inflated stocks. (Fraedrich, Ferrell & Jackson, n.d., pp. 390-391). Thus, it is observed that the chief executive officer of the Countrywide Financial through the continuous draining of company funds and resources had contributed greatly in letting the company fall. Q.4. How should Bank of America deal with potential ethical and legal misconduct discovered at Countrywide? A.4. One of the leading financial institutions operating in the region of United States, the Bank of America acquired Countrywide Financial for an amount of $4 billion during the financial year 2008. The Bank of America’s acquisition of Countrywide Financial was observed as a positive event for it would render support to the investigatory activities carried on regarding the fraudulent activities of the firm. The taking over of Countrywide Financial by Bank of America reflected some activities like taking over of the company’s huge debts. In fact, a report issued by the Securities and Exchange Commission of United States stated that debts amounting to $16.6 billion of Countrywide Financial were taken over by Bank of America. Further, Bank of America also planned to exit the subprime loan market in which Countrywide Financial was an active player. It was observed that Bank of America during the financial year period 2008 to 2009 planned to sell off property amounting to $26.3 billion acquired through subprime loan business. Further, Bank of America arranged for a huge relief fund ranging to around $8 billion to render assistance to 397,000 people who have suffered due to the fraudulent loan generation practices of Countrywide Financial. The rates of interest charged on the housing loans generated were brought down significantly by Bank of America to around 2.5 percent. The result of such activities taken up by Bank of America to help revive Countrywide Financial created a heavy impact which made the bank incur a huge loss. However, Bank of America showed optimism in stating that housing prices would standardize by the close of the 2009 period. (Fraedrich, Ferrell & Jackson, n.d., pp. 388, 391-392; Barr & Goldstein, 2008) References 1. Barr, A. & S. Goldstein. (2008), Bank of America to buy Countrywide Financial. Retrieved on December 18, 2010 from: http://www.marketwatch.com/story/bank-of-america-to-buy-countrywide-financial-for-4-billion 2. Garcia, M., Gonzalez, I., Goroway, D., Mellis, S., & M. Sarmiento. (n.d.), Subprime Lending-Illegal, Unethical, or Both? Retrieved on December 18, 2010 from: www.spc.edu/MediaFiles/GradBusiness/SubprimeShadyBusiness.pps 3. Fraedrich, J. Ferrell, O. & J. Jackson. (n.d.), Countrywide Financial: The Subprime Meltdown. 4. “How do I choose an ethical subprime lender?”, loan.com. (n.d.). Retrieved on December 18, 2010 from: http://www.loan.com/home-loans/how-do-i-choose-an-ethical-subprime-lender.html 5. Lander, G., Barker, K., Zabelina, M. & T. Williams, (2009). Subprime mortgage tremors: an international issue. Retrieved on December 18, 2010 from: http://www.entrepreneur.com/tradejournals/article/195658952_1.html 6. Weston, C. (2006). Unethical sub-prime lenders slammed. Retrieved on December 18, 2010 from: http://www.independent.ie/business/irish/unethical-subprime-lenders-slammed-86958.html Read More