The sub-prime mortgage crisis - Essay Example

Write an essay discussing the ethical issues that arise from the recent collapse of the US sub-prime mortgage market (the sub-prime mortgage crisis). The US sub-prime crisis is the historic turning point in the US economy and global culture. It is the result of the collapse of the speculative bubble in the housing market that began to burst in 2006 and has had rippling effects across many countries in the form of financial failures and global credit crunch. The current credit crisis which is the wave of the collapse of the US sub-prime mortgage market can be evaluated by understanding the history which is associated with it in terms of the effects it has had on the borrower as well as the financial statements of the banks, other financial institutions and the investors in the mortgage backed by securities around the world (Walters, 2008). The mortgage lending market is divided in two sectors prime and sub-prime. Prime borrowers are marked by high income, strong credit rating and sound savings. Sub-prime mortgages are loans which are extended to borrowers who have low credit score, no savings, blemished credit history and weak debt to income ratio. Sub-prime borrowers are considered riskier by the lending institutions and are generally assessed at higher interest rates than the prime borrowers. The sub-prime mortgage market emerged and flourished in the 1990's. The new trend of extending loans or credit to borrowers with less than perfect profiles was adopted in 1990's and continued until 2005, resulting in increased homeownership recording 64.1 % in 1993 and 68.9% in 2005(Carpenter,2008). The expansion of sub-prime market improved the access of credit and resulted in the boom in the real estate market. This also led to the expansion of credit to those borrowers whose credit was blemished. This period was also backed by strong overall housing market with increasing value of the home prices. Though this trend did not continue and in 2006 the housing market began to slow down, which resulted in rising late mortgage payments, foreclosures and defaults. This resulted in the collapse of the US sub-prime mortgage market. The crisis had widespread impact on the borrowers, investors, financial institutions, securitization, and mortgage broker which led to more involved government regulation. With the emergence of the sub-prime mortgage on the larger scale, there has evolved a new term in the lending world 'predatory lending'. It was seen that as sub-prime market increased so did predatory lending in some form or another. The Joint Report offered this definition: "In a predatory lending situation, the party that initiates the loan often provides misinformation, manipulates the borrower through aggressive sales tactics, and/or takes unfair advantage of the borrower's lack of information about the loan terms and their consequences. The results are loans with onerous terms and conditions that the borrower often cannot repay, leading to foreclosure or bankruptcy" (Carpenter, 2008). This brings in the ethics applied in the lending industry where sub-prime lending can be encouraged and predatory lending can be controlled using regulatory authorities. Owning a house is very noble desire very intrinsic to the happiness of the human beings. When the system goes against this virtue and creates more damage to the parties concerned it becomes a widespread crisis. Sound ethical practice applied to different segments of the mortgage industry will provide a channel which will help solve this ruthless money making machinery from exploiting the situation of nave customers or borrowers. The first time home buyers are elated and confused. It is an intimidating experience for the borrowers especially if they have been declined credit because of their income or credit history. It is a challenging task to negotiate the maze of loan processing which are overwhelming in terms of loan terms, fees, and financing documents. Most of the time borrowers place their trust in the broker or the lending authority which initiates the loan processing. This creates the probability for abuse by lenders if they are unscrupulous. They take advantage of the borrowers by changing the terms and the fees related to the loan agreement. This agreement in many cases may be profitable for the lenders, but may not be in the best interest of the borrower. This leads to a situation in which if loan terms are too burdensome, then there is the likelihood that borrowers may default on their contractual agreement, this increases the likelihood that lenders may foreclose on the mortgage and force the borrowers out of their home. This is a negative experience for the borrower, broker, lender and the market in general. This impacts the lives of many in the chain and hence ethical consideration is of great importance in such situation. It implies good ethics for all involved. The fine line between valid sub-prime lending and predatory lending has been a very difficult task. This brings into consideration the long established moral virtues of Aristotle into light. According to Aristotle moral virtues are the states of character which are determined by practicing "mean between the extremes of excess and deficiency"(Payne). Moral virtue implies consideration of feeling, choosing and acting well. He believes in 'the doctrine of the mean', which would help a person identify between virtues and vices. In the context of the sub-prime mortgage it is important to understand the validity of the terms, fees and obligations in the context of the borrower. It is important to determine when a certain rate of interest and fees become more onerous loan terms taking shape into predatory lending practices. This requires that the lending mechanism should adopt appropriate legislation to curb these practices. It is important to maintain a balance and mean in terms of Aristotle's theory; as availability of credit has its own advantages. If the restrictions on the lending practices are tightened, it will damage the credit availability for sub-prime mortgage where the credit history is blemished. This could potentially dry up the market. This would also result in many potential homeowners being declined of home-owning choices. On the other hand if the restrictions are very loose, then borrowers may be stripped of the equity in their homes by the sharks that practice unscrupulous lending practices. This unnecessary loss of equity which are result of the points, fees or rates leading to more expensive loans than the borrower can afford and qualify for has its own drawbacks considering the borrowers financial status and other criteria's which are detrimental to the borrower. This adversely impacts the low income, sub-prime borrowers who have few savings other than equity in their home. This will result in sub-prime crisis. There is a great possibility that the sub-prime crisis will impact the economic and collateral market for years. The damage will threaten and disrupt the credit market in manifold dimensions and historic proportions. The crisis will also set into motion very strong societal changes which would affect the consumer habits, values and everyday functioning. There will be a lurking threat of uncertainty mounting the decision related to economic considerations. The forces which are unleashed by the sub-prime crisis has the potential to have uncontrolled impact on the financial sector for a long time. In the light of the Aristotle's theory of ethics and virtue, such extremes should be impeded before it causes damage not only to the economy but also to the social fabric. It is very important to take measures which would hold the trust and the optimism which people feel for each other for their collective financial institutions and the ways of life for years to come. In the light of the sub-prime crisis it is important the social fabric is not overlooked and the details and the elements which impact the social fabric should be addressed timely to control the negative impact. Social fabric is at great risk and should be considered a central issue for consideration when the response is evaluated in connection to sub-prime crisis. The collapse of the economic system should not include within its flames the collapse of the social structure. Timely intervention and moderate considerations are necessary to reinstate the faith in the financial institutions and social fabric should be the focus of consideration. History has proved the importance of sound economic policies which can ascertain preservation of the social fabric even during the time of World War I (Schiller, 2008). The present sub-prime mortgage collapse is of great magnitude and has deeper impact on the economic and the psychic state of the people. In the context of ethical view presented by Aristotle, they are presenting a stiff hindrance to the achievement of good life which is essence of Nichomachean Ethics. A major disaster is brewing today in which many people are subject to fraud and unscrupulous practice by the mortgage brokers and investment houses. Many people are not able to repay their debts, and are hunted down by their creditors aggressively. This leads to a situation which is not their own making but is an outcome of forces which are beyond their control. There is evidence that economic institutions, brokers and investment houses have allowed the situation to get out of hands. The once trusted economic institutions are collapsing around the globe leaving people worse off than they were before. There is a deep resentment which has been outcome of the misinformation fed based on which excessive risk was taken with their lives and money. This experience is hindrance to a good life theory which involves the codes of ethics which regulates and governs the character to ensure happiness and satisfaction. This collapse of the sub-prime mortgage market will have long term impacts which will be impossible to predict in its nature and the extent of damage to the economic system as well as the social fabric. It will be measured in terms of slower economic growth for many years to come. People will experience several years of bad economy, and decades of growth may be impeded as it happened in Sweden, Mexico and Japan (Schiller, 2008). The ethics of the people involved is in question. "An account of the crisis seems to place the ultimate blame on factors like growing dishonesty among mortgage lenders, increasing greed among securitizes, hedge funds and rating agencies"(Schiller, 2008). The ethical values need to be kept in place in the light of this consideration. "It is important to recognize what has been happening and to take fundamental steps to correct and restructure the institutional foundation of the housing and the financial economy"(Schiller, 2008). These long and short term steps are necessary to alleviate the impacts of the crisis which will hold back the development of the bubbles, stabilize the housing market and larger financial institutions to provide greater security to households and businesses. This also requires an innovative outlook on financial systems which can address the needs of the householders and businesses to guarantee financial security. An evaluation of the chain effects which led to sub-prime crisis has been identified as aggressive mortgage lending, compliant appraisers, and complacent borrowers who spread right across the chain to feed the housing boom. The first ethical dilemma begins with the mortgage originators, who aggressively convinced the borrowers and had ulterior plan to sell off the mortgages to securitizers. They did not stop to think about the welfare of the borrower and also about the repayment process and capacity of the borrower. They did not evaluate the capability of the borrower thoroughly and just made superficial efforts to assess the borrower's ability to repay their loan. They did not verify the borrower's income with the Internal Revenue Service. They just accepted the borrower's words on self verification. The process was not given full consideration. They also used their aggressive selling tactics to entice the borrower in the ballooning sub-prime mortgage market. The new trend was to package, sell and resell the mortgage using sophisticated methods and techniques to investors around the world. This is what created the ripple effect of the collapse on the high global magnitude impacting global economy. This housing bubble encompassed in its flames an incentive system which impacted the securitization process, a moral and ethical issue and led to some of the worst unethical conglomeration of individuals and institutions across the chain. The worst role was played by mortgage brokers who benefited and misinformed both the borrower as well as the investor. The focus on the booming real estate was so profitable and tempting that it led to an exodus of new homes. Surprisingly "the share of residential gross domestic product rose to 6.3% in the fourth quarter of 2005, the highest level since the pre-Korean War housing boo, of 1950-51"(Schiller, 2008). The outcome of this new emerging residential sector led to glut in the market. The leaders did not see it, but the US home prices began to fall by mid 2006. As the prices declined at an accelerating rate the boom in home construction collapsed leading to many out of their desired homes, many lenders suffering from losses and many investors felling the impact worldwide. This led to the locking up of the world credit markets. The current financial crisis has been an eye opening event which takes us back to ancient theory of ethics and morality which is the inherent part of Aristotle's teachings. This happened because in the light of modern success, the individual compromised with the character building traits which are the essence of happiness and good life. We find a chain of people and institutions which formed a conglomeration of mere economic values based on greed. This wave reached the far borders of national territory and impacted global investors as well. Borrowers, housing investors, financial institutions, securitizers, mortgage brokers as well as government regulation agencies all became part of this big game plan which did not reach a happy end. This is a lesson to rationally evaluate life and its values according the ethics and morality and return to old and simpler methods of financial dealings. One should also in the light of the old tradition device innovative methods to rethink and improve the current risk management institution. It is time redouble the efforts globally to provide proper check and balances in the financial sector. This is also the historic moment to use the technology, cutting edge information and global support to reinvent a modern finance which can provide the framework for initiating a powerful engine of economic growth. "Institutions should direct their financial activity in a positive way to stabilize the economy, reinvent wealth of nations, reinforce beat of financial innovation and leave society better off than if there had been no such crisis."(Schiller, 2008)The answer to the present crisis is an institutional reform which provides stronger framework within which the real estate and financial market can operate beneficially for the society. Work Cited Walters, Patricia Doran (2008). The Institute of Chartered Accountants in AustraliaThe collapse of the US sub-prime mortgage market Understanding the impacts under IFRS. The Institute of Chartered Accountants in Australia, Retrieved 10-5-08, from www.charteredaccountants.com.au/files/documents/Credit_Crunch_Report.pdf (Walters, 2008) Carpenter, David H. (November 23, 2007). CRS Report for Congress A Predatory Lending Primer: The Home Ownership and Equity Protection Act. Retrieved 10-5-08, from http://assets.opencrs.com/rpts/RL34259_20071123.pdf ( Carpenter, 2007) Carpenter, David H. (February 29, 2008). CRS Report for Congress :The Primary Residence Exception: Legislative Proposals in the 110th Congress to Amend Section 1322(b)(2) of the Bankruptcy Code. from http://assets.opencrs.com/rpts/RL34301_20080229.pdf ( Carpenter, 2008) Shiller, Robert J. (2008). Robert J. Shiller: The Subprime Solution. Princeton University Press, from http://press.princeton.edu/chapters/s8714.pdf ( Shiller, 2008) James R. Barth, Tong Li, Triphon Phumiwasana, and Glenn Yago, (2008)MORTGAGE MARKET TURMOIL: THE ROLE OF INTEREST-RATE RESETS. Milken Institute, from http://www.ghb.co.th/en/Journal/Vol2/07.pdf (Barth, Li, Phumiwasana& Yago, 2008) Greenfield, Susan (2008). Global Demand for Information on U.S. Mortgage Market . Retrieved October 5, 2008, from NATIONAL ASSOCIATION OF REALTORS Web site: http://www.realtor.org/IntUpdt.nsf/Pages/GlobalDemandforInformationonU.S.MortgageMarket (Greenfield, 2008) Neergaard, Jens Peter (2008). Young Professionals :The Perfect Storm. Danske Markets, from http://www.danskebank.com/da-dk/Job/Specialist/Young-Professionals-Forum/Documents/Jens%20Peter%20Neergaard.pdf ( Neergaard, 2008) Payne, W. Russ Aristotle on Virtue. Retrieved October 5, 2008, Web site: http://facweb.bcc.ctc.edu/wpayne/aristotle_on_virtue.htm Payne, W. Russ Aristotle on Ethics. Retrieved October 5, 2008, Web site: http://facweb.bcc.ctc.edu/wpayne/aristotle1.htm Scott, Alex (2002). Aristotle's Nicomachean Ethics. Retrieved October 5, 2008, Web site: http://www.angelfire.com/md2/timewarp/ethics.html ( Scott, 2002) Read More