Explain Ethical Issues with Subprime Loans
Ethical Issues with Subprime Loans
Ethical Issues with Subprime Loans: Blog
The term subprime is defined as the credit ability or quality of a borrower who has a destabilized history of credit and a higher probability of defaulting on loan payment compared to prime borrowers. Following the financial crisis that hit America in 2007, much focus has been placed on the subprime lending industry considering the part this industry played in the aforementioned financial crisis. Most of the focus has been directed at the decisions of the lending institutions to offer these loans to people and the ethical issues associated with the total subprime loans. As such, this blog shall explain the ethical issues with subprime loans in three entries.
First Entry: A summary of the concept of subprime loans and the risk they pose to the borrowers or lenders.
The subprime lending created a new foundation of prospective profits for the lending institutions while creating investment opportunities for individuals with a destabilized history of credit worthiness. This concept allowed these people to obtain loans that were beyond the reach (Watkins, 2011). The most common form of subprime loans is the subprime mortgage. These loans are given at higher interest rates by the lending institutions with the aim of reducing or diluting the risks of losses, in the case of default in payment (Gilbert, 2011). Borrowers that are included in the category of subprime borrowers are considered to be those with a score of less than 600.
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Further, in most cases, the loans are first given at a teaser rate which usually reset after two years at an increased rate. This process is referred to as the Adjust Rate Loans (ARM). Once they are reset, the consumer has restricted options and in case he or she in unable to settle the newly adjusted rates, he or she could face foreclosure. Other than the inability to pay the loan, the higher rates may be given as a result of lack of documentation as well as reducing the standards of credit by the banks (Doms, Et.al, 2007).
The risks associated with subprime loans are evident. First, there is a possibility of foreclosure and loss of related collateral for the borrower. The increase in prices of housing made subprime loans come out as risk-free. As a result, lending institutions did not put emphasis if the borrowers failed to pay as they were or the opinion that they did not mean to have the loans until maturity; rather, they would lessen the risks by slicing, bundling and dicing these loans then selling the loans to the Wall Street. The Wall Street would then package the loans into bonds thereby selling them to global investors (Watkins, 2011). Also, lending institutions had the authority to assume the foreclosed investments since they thought the prices of housing would increase further. They were dealt a blow in 2007 when housing prices began to decrease, ensuing in massive losses for the lending institutions which led to the financial crisis in 2007 and 2008.
Second Entry: A critique or analysis of the role of leadership decision making in the subprime loan financial crisis.
According to Gilbert (2011), decisions are made by individuals and not organizations and when individuals make the decisions, they must or should take responsibility for their decisions. In essence, an organization only lays a framework within which the process of decision making can be created in an organized manner. However, there are ethical or social responsibilities when individuals act on behalf of their organizations. In this regard, when examining or assessing decisions made, it is important to understand the fact that the people making these decisions do so on behalf of their organizations and this places on them an obligation of social and ethical responsibility. According to Thiel, Et. al, (2012), the behavior of the leaders of an organization or the choices made by these leaders must conform to the ethical standards and requirement of the business ethics. However, even though there are several procedures and policies that enable leaders avoid unethical behavior or protect themselves from making choices that qualify as unethical behavior, most leaders still find themselves in these situations. Essentially, leaders are affected by challenging the decision and are more susceptible to unethical dilemmas as a result of the vague nature of choices in business with regards to the inferior principles of the models of business that are considered acceptable until they are put in the spotlight. With these concerns and facts, leadership decision making needs to focus on those decisions that are not likely to be regarded as unethical behavior since their decisions affect both the internal and external environments with regards to the business or organization. In this regard, the banks or lending institutions’ leadership had a part to play in preventing the financial crisis since this crisis was down to their decisions to give more people the financial power in the market. As such, before making these kinds of decisions, the leadership should assemble all the possibilities, both negative and positive, and foresee the consequences and the outcomes associated with their decisions so as to make moral, ethical and rational decisions.
Third Entry: Evaluation of the subprime loans with the notion of social responsibility, comparing and contrasting the resulting consequences for these actions as well as indicating the measures that have been taken since that time to ensure crisis never happens again.
According to the business ethics, the concept of social responsibility states that banks and any other businesses should not only center on creating profits but also should be apprehensive of the ecological and social consequences linked to their decisions (Elkington & Fennell, 1998). This concept evidently implies that banks have failed in their responsibility to the consumers and the society since most of their efforts are mainly aimed at making profits for their business and shareholders.
With regard to subprime loans, banks and lending institutions did not apply their social responsibility to the borrowers and investors. For instance, before the financial crisis, lending institutions had the most assets in the stock market; after the crisis, most of these assets were lost. Borrowers also had the same fate as the lending institutions as they also lost their investments in the financial crisis. However, in as much blame is put on the lending institutions for the crisis, some of the responsibility should also be placed on the investors and borrowers for their part in initiating the crisis. Nonetheless, more responsibility should be placed on the lending institutions for enticing investors with the subprime loans thereby placing more investment power in the hands of many people.
Finally, there have been a number of laws, regulations, and policies that have been put into practice since the crisis happened. These policies and laws have been aimed at restricting the banks and lending institutions from taking part in some forms of behaviors and investments (Blinder, 2013). These measures include:
First, in 2010, the financial reform was passed to curtail recklessness by preventing banks from dealing for their interest, while ignoring the needs of the clients. The rationale for this policy was premised on the fact that the taxpayers who support the banks should not suffer as a result of the reckless behavior of the banks.
Secondly, in the same year, the Congress passed The Wall Street Reform and Consumer Protection Act and immediately signed by President Barrack Obama. The act worked to do away with the office of the Thrift Supervision and bestow more influence to the Federal Reserve to control all the large institutions of finances. Also, this act established a more influential consumer financial protection responsibility for the Federal Reserve by the formation of Bureau of Consumer Financial Protection. In essence, the new laws reduced the power of the banks to control financial matters and gave the powers to the government to ensure the banks act in the interest of the consumers and not in their interest.
Blinder, A. S. (2013). After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead. Penguin Group USA.
Doms, M., Furlong, F., & Krainer, J. (2007). Subprime Mortgage Delinquency Rates. Federal Reserve Bank of San Francisco Working Paper, 33, 1-29.
Elkington, J., & Fennell, S. (1998). Partners for Sustainability. Greener Management International, 48-48.
Gilbert, J. (2011). Moral Duties in Business and their Societal Impacts: The Case of the Subprime Lending Mess. Business and Society Review, 116(1), 87-107.
Thiel, C. E., Bagdasarov, Z., Harkrider, L., Johnson, J. F., & Mumford, M. D. (2012). Leader Ethical Decision-making in Organizations: Strategies for Sensemaking. Journal of Business Ethics, 107(1), 49-64.
Watkins, J. P. (2011). Banking Ethics and the Goldman Rule. Journal of Economic Issues, 45(2), 363-372.
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