The subprime mortgage crisis, commonly referred to as the “mortgage meltdown,” unveiled itself after a sharp increase in home foreclosures beginning in 2006, which unfolded seemingly out of control by 2007. American spending declined, the housing market plunged, foreclosures continued to climb and the stock market was shaken. The subprime crisis and resulting foreclosures prompted discord among consumers, lenders and legislators all bound to one another by a web of complex financial engineering. The event represents a turning point in the world economy and our culture as fundamental societal changes are needed to rebuild the relationship between the U.S. government, Wall Street institutions, and the average American. Unethical decisions from various parties have altered the way future business will be conducted as the current economic and political policies were unable to confront the crisis before it unraveled. This paper is focused on investigating the unfavorable effects of the current financial system structure established on unbreakable bonds of linkage among American communities and financial institutions.
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Initially, many financial experts including the International Monetary Fund (IMF) believed the crisis would be limited within the arena of mortgage lenders who had accumulated these subprime loans. But as time progressed there was an evident spread into the prime commercial and residential real estate markets as well as an impact on consumer credit. In an April 2008 “Global Financial Stability Report,” the IMF criticized “the excessive risk-taking and weak underwriting undertaken by under-capitalized institutions and recommended measures including ratings systems reform and a change in compensation schemes for managers of financial institutions” (Smith, 2009, p. 2). According to the IMF, there was a collective failure by financial institutions for not properly managing risk. The New York Times columnist Michiko Kakutani (2010) would add there were “flawed mathematical models that most financial executives did not really understand themselves” (Kakutani, p. 1). Essentially, Wall Street firms turned subprime mortgages “into exotic, toxic financial products by making a fortune laundering and reselling, and they were enabled in doing so by the very ratings agencies that were supposed to police risk” (Kakutani, p.1). Even as the quality of the underlying loans appeared sketchy, few could have expected how the severity of the subprime fallout would threaten the U.S. economy to the degree it has so far.
The idea behind subprime loans is borrowers who do not meet the credit requirements for prime mortgage loans are required to pay higher interest rates and fees than prime mortgage loans. Since a significant portion of new home ownership expansion stems from buyers with a lower income compared to historical norms, the initial down payment is relatively low. This creates more risk for lenders and requires higher interest rates attached to the monthly mortgage payment. The difference between the social and economic impact of historical home ownership compared to the subprime situation is the earlier loans created real ownership and wealth, which could be passed along to future generations. The illusion of wealth in subprime lending has led to instability within families and communities as many low-income borrowers were enticed by the ease of becoming a first-time homeowner (Muolo, 2008, p. 277-303).
It’s important to consider how subprime borrowers came from lower income families. Due to lower savings, they are unable to pay the typical 20% down payment on a house, thus requiring near 100% financing. This new form of lending allowed families who had previously been excluded from home-owning to participate in “affordable housing” programs. It was even referred to as “creative financing.” The common question at hand is identifying who is to blame for allowing the capital market economy to create irresponsible home ownership. Much of the subprime homes never yielded real wealth as outright ownership of the home was highly unlikely.
Subprime lending to low-income people illustrates how leaders in power are able to raise awareness to followers that home ownership is a moral obligation. “The leaders have demonstrated their ability to ‘raise followers’ consciousness about what is and ought to be important to them” (Ciulla, 2003, p. 220). The idea of home ownership even became a political agenda to make people feel like they deserve a new home. Comparisons could be made that our government was almost behaving as a Jim Jones leader. Jim Jones appealed generally to impoverished and minority individuals who felt oppressed and besieged by a hostile world. Similarly, the government allowed subprime lending to target individuals who were historically turned away.
ETHICAL ANALYSIS OF MARKET CONDITIONS
Understanding the ethical behaviors of the subprime fallout is rather challenging as many dynamics stem from the individual as well as from a societal level. First of all, a new research paper conducted by three respected Irish economists point to a common factor of “irrational exuberance” among the real estate bubbles experienced in America and Ireland. “In both countries, buyers and lenders convinced themselves that real estate prices, although sky-high by historical standards, would continue to rise” (Krugman, 2010, p. 2). Consequently, this prevalent belief cannot be explicitly linked to an individual as society collectively accepted these trends. Additionally, the common social viewpoint that rising incomes would continue to accommodate the rising price of homes is not any individual’s responsibility. Perhaps, the forecasting models used by economic experts were excessively optimistic, but this does not make them morally irresponsible. Robert Shiller (2008) argues “the housing bubble that created the subprime crisis ultimately grew as big as it did because we as a society do not understand, or know how to deal with, speculative bubbles” (p. 3). It is difficult to affix an ethical verdict to something as uncontained as the market.
However, a slice of moral accountability should be ascribed to key leaders who have control in shaping the market. There was a form of “regulatory imprudence as the people charged with keeping banks safe didn’t do their job” (Krugman, 2010, p. 2). While many regulators looked the other way, the bigger issue is the ideology based on free-market fundamentalism where deregulation was thought to strengthen the financial system. The Federal Reserve chairman, Alan Greenspan, was criticized for maintaining low interest rates that further provoked subprime lending. Due to many stakeholders in the subprime story, blame has been placed on many factors such as “a growing dishonesty among mortgage lenders, increasing greed among securitizers, hedge funds, and rating agencies” (Shiller, 2008, p. 4). But, we can identify that Greenspan had direct control over key monetary policies such as interest rates, with foreseeable impacts. Justifying whether poor judgment was made in these decisions illustrates a moral question of his accountability. Many others question how well the government addressed regulation policies and the freedom given to banking institutions to issue reckless lending.
It is also logical to believe the government essentially allowed an over inflation of homes in the market. Their openhanded efforts in rescuing weakening financial institutions beginning in 2008 with Bear Stearns, then AIG, and many others may indicate a form of duty the government has to help make amends for allowing too many Americans to have a mortgage they are unable to afford. The American financial system is “filled with firms that disdain the need for government regulation in good times but insist on being rescued by the government in bad times” (Kakutani, 2010, p. 2). Nevertheless, prescribing all of the liability upon the government or Federal Reserve is too unbalanced. The complex nature of the economic conditions related to the subprime crisis is larger than what any single stakeholder could instigate.
Helping to fuel new mortgages, brokers sought to attract home-buyers with no money down agreements. Some likely acted of the premises that housing values and real incomes would gradually keep climbing to create a win-win situation for both parties. Again, to assign a moral indiscretion to a specific mortgage broker supplied with the best available public information to guide potential buyers is unsupported. It is not appropriate to directly attribute their actions to the subprime meltdown. But, as we continue to analyze behaviors we will see how many individuals took advantage of the economic zeal that fueled the subprime crisis (Cohan, 2009, p. 92-108).
Much of what has been discussed points to the common belief of increasing prosperity and as well as a general unsupported belief in maintaining such high growth. There is quite a fine line between having sustained optimism for a bright future and a greed-like attitude that tries to hide the reality of an eventual economic decline. Would it be acceptable to morally blame society as a whole for overlooking the apparent signs of danger? Not fully. Yet, as more players in the market are outlined in the following sections we will see how the rules of the game may have deliberately hurt others.
ETHICAL ANALYSIS OF KEY PLAYERS
To expand upon the market condition section previously discussed the moral responsibility in the transactional loan process is analyzed next. There is a duty for each party to have transparency and truthfulness when completing a deal. Ideally, the consumer is obligated to pay loans they agree upon with the broker. As government leaders portray the promise for all Americans to have prosperity, home ownership became a reality for the most economically impoverished people. We begin to see a fabrication of falsely portrayed subprime loan applications by consumers captivated by these lucrative opportunities to have a new house. It would seem morally wrong for a person to falsify information, as most people should only want to acquire a loan they can manage with financial responsibility. However, the self-interest of satisfying their desire overcame the normal way of managing finances. There also presents a moral hazard to the broker who works for commission by getting people to sign agreements and has no financial liability afterwards. Is the broker seeking the best interests in protecting customers? We realize the lack of concern by many brokers who overlooked the details. Ironically, as many of the brokers did not fully consider the unethical transactions, they are now the ones out of a job (Andrews, 2009, p. 133-148.).
Furthermore, the lenders or banks are presented with ethical considerations as to how well they scanned applicants before providing loans. Were loan requirements not strict enough on purpose? It would seem a bad business practice to grant loans knowing customers will have late or no payments towards the principal of the loan. As we have learned, the banks ended up selling the bad loans to investors. The analysis up to this point seems to be pointing toward the idea that owning a home is becoming a morally acceptable idea and a basic right for everyone. Envision subprime loans as being a prescription drug. When placed in the hands of a diagnosed person in need of the drug, it can bring about social good, but if given to a teenager, who has no need for it, the drug can lead to destruction. This illustration shows how subprime loans require proper structuring to provide the most good.
ETHICAL ANALYSIS OF FINANCIAL INSTITUTIONS AND INVESTORS
Containing the misfortunate subprime loans solely between the lender and consumer could have benefited and alleviated the crisis if the loans were able to be paid by the new homeowner. But, due to lenders not making any profit on the loans they are forced to sell bad mortgages by packaging them in the form of collateralized debt in hopes of selling to investors who believe the value of the mortgage assets will increase. Again, we are confronted with the moral issue of how transparent these debt packages are represented. Do investors deserve better warning of the extreme risk of buying mortgage debts? Who is ultimately ethically accountable for selling bad debt? Everyone seemed to be caught up in this euphoria where no one expected anything bad to happen.
To break down some of the moral culprits of passing along bad loans, many financial agencies were persuading clients to invest in bad debt, while at the same time these organizations sold off the loans to avoid any further losses. The apparent misuse seems morally wrong as they knowingly caused harm to investors. The rating agencies are also tossed into the blame game. “Wall Street firms knew how to game the system; they knew how to get the rating agencies (which were eager to collect big fees for their services) to ineptly rate dangerous bonds” (Kakutani, 2010, p. 2). Who is to protecting the financial stability of the economy by inaccurately rating risky subprime loans? Too many people assumed continued economic growth and overlooked the likelihood of the bubble bursting (Mason, 2009, p. 81-90). Overall, much of the calamity of the mortgage meltdown is due to the collective failure of society in a business and government sense to foresee the collapse, making it difficult to assign responsibility.
The various examples presented have illustrated the “psychology involved in the real estate bubble” (Schiller, p. 4). From Paul Mason’s (2009) book we not only have witnessed “capitalism’s tendency to expand the power of the market to push for the maximum freedom” (p. 171), but the tendency for a “double movement” as ascribed by the Hungarian philosopher Karl Polanyi. As free market expansion oftentimes reduces the relationships between families, nations, and social classes to a mere commercial level based on money, a counter-tendency arises to defend common human values and community. The dynamics of the economy will require a “willingness of ordinary people to impose limits, standards and sustainability on capital” (Mason, p. 172). The current form of our markets have possibilities for limitless growth, yet the often selfish and unequal society in which we live in has created repeated financial distress.
As many people point to banks for significantly contributing to the economic downfall, understanding how philosophers approach the situation is important to further our awareness of the problem. The premise of Immanuel Kant’s categorical imperative is based on the morality of the act, not outcomes, meaning an act may be done for the right reasons, even if it has bad consequences (Ciulla, 2003, p. 95). So, how can a lending institute be judged as unethical for issuing loans to help customers purchase a home? The morality failure, based on this stance would not fall on the bank. But, consider Kant’s statement that “all rational beings stand under the law that each of them should treat himself and all others never merely as a means but always at the same time as an end in himself” (Ciulla, 2003, p. 107). If the bank fails to appropriately evaluate the client’s ability to pay back debt, then they are treating the client as a means for their own financial benefit and are eventually leading their clients to an ethical failure. On the same token, the brokers who never bothered to properly perform background checks on their clients were also satisfying their own financial desires, rather than helping customers make sound financial choices.
John Stuart Mill’s utilitarian approach “emphasizes multiplying happiness, or making life better for the majority of stakeholders in an organization, a community, or a country” (Ciulla, 2003, p. 143). Therefore, Mill would view the lending institutions as providing moral value to the individuals seeking to gain home ownership. The general economy and government polices were allowing and expanding housing programs, in which there was a collective agreement that having people buy homes was a good strategy for the country. We now realize the greatest good often looks different in the short term than in the long term. In retrospect, too much emphasis may have been placed on the present and not enough concern on potential consequences of too much lending. The multiplication of happiness for those involved in subprime lending only lasted until the foreclosures and collapse of the banking industry began.
Just as Kant and Mill’s viewpoints speak of the moral behaviors among the parties involved, Ayn Rand offers insight by arguing that “every man – is an end in himself, he exists for his own sake, and the achievement of his own happiness is his highest moral purpose” (Ciulla, 2003, p. 47). Her position seeks happiness proper to man and does not advise seeking happiness through fraudulent schemes as this approach will lead to frustration. “She believes morality’s purpose isn’t to command you to sacrifice your interests for the sake of others but rather to teach you the rational values and virtues happiness in fact requires.” (Ghate, 2009, p. 3). In hopes of restoring society to the place we were before the collapse, Rand would not place the primary blame on the people, but the immoral system in which they had to act. There should be a reevaluation of what genuine self-interest consists of and whether the pursuit for happiness is moral.
As mortgages have become a norm in the American society, there is an underlying meaning to the origin. The word “mortgage” comes from the Latin words, “mort” and “gage.” Mort means death, and gage means a pledge to forfeit something of value if a debt is not repaid.
The basics of mortgages have remained the same; high value real estate which cannot be funded by most people results in borrowing money to buy property. Many people are enslaved to meet the death pledge they signed. Borrowers should be aware of what they are doing and realize it is not always justifiable to blame the banks, as they ultimately cannot force an individual to take on a mortgage obligation. (Marples, 2008, p. 2)
There seems to be a moral dilemma confronting families who still owe more on their mortgages than what their home is worth. “Should they sacrifice to pay their mortgage even though their home’s value may not recover for several years? Or should they simply walk away” (Merrel, 2009, p. 2)? If they made an agreement with a lender to pay the loan, then on the surface it would seem morally right to continue paying for the home. After understanding the significance of a death pledge, we could argue “mortgages are not ethical documents, they are legal contracts” (Merrel, 2009, p. 2). So, if a person decides to stop paying their mortgage, they simply “pledge” the ownership of the home back to the lender. Nevertheless, realize a mortgage contract entails a promise to pay and walking away from a promise in a way leads to a breach of ethics. It seems that determining whether it is morally justifiable in walking away has to be examined on a case to case basis.
In respect to the people who lost their homes due to unemployment or other valid reasons, they have a right to be upset for how the careless decisions of others hurt their “American Dream.” It has turned into just that, a dream, as society allowed people to believe they deserve a home they cannot afford. John Rawls, a Harvard philosopher, offers insight to the economic and moral issues societies confront regarding distributive justice. He argues as self-interested rational beings governed by principles that oppose discrimination, everyone should have equal liberties and fair distribution. He speaks of inequalities among social class wealth as only being just “if and only if they are part of a larger system on which they work out to the advantage of the most unfortunate representative man” (Ciulla, 2003, p. 158). Why should we be making life better for those who are already well of with nice homes and do nothing for those who are already underprivileged? Perhaps, as in the case of subprime lending, there was an outreach by leaders to provide equal opportunity to the least advantaged persons.
In order to learn from the U.S. financial crisis, we have to enforce action by people who see it as their duty to protect the American people. “We have to focus as much on the regulators as on the regulations” (Krugman, 2010, p. 2). Financial consumers need protection from being taken advantage of or else we will have failed to learn from our recent history and can expect to repeat it again.
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