The Solution to the Problem?

Tags

Consumer Financial Protection Bureau, Fannie Mae, FCIC, Financial Crisis Inquiry Commission, Fordham Urban Law Journal, Goldman Sachs, Government, Lehman Brothers

In my last blog, I discussed risks, both borrower and lender, as well as lender social responsibility.  Now, I wish to discuss measures taken to prevent the reoccurrence of such a financial tragedy.   

An economic disaster of such proportions could not escape even the attention of the United States Government.  Public Law 111-21 created the Financial Crisis Inquiry Commission (FCIC), an independent investigative authority comprised of ten subject matter experts (FCIC, 2011).  The Commission held nineteen days of public hearings, and interviewed over 700 witnesses, and examined millions of document pages from prior committees, government agencies, legal and journalistic investigations, and other sources as they were identified (FCIC).    By Federal law, the Commission investigated twenty-two specific topics, and individually addressed business practices of individual lenders, including AIG, Bear Stearns, Citigroup, Countrywide Financial, Fannie Mae, Goldman Sachs, Lehman Brothers, Merrill Lynch, Moody’s and Wachovia (FCIC).  If you want to read more about FCIC, click here.

Though many consider the FCIC’s efforts a success, granted to varying degrees, some debate this stance.  The FCIC budget was limited to ten million dollars, a paltry amount indeed when compared to one company’s, Fannie Mae, sixty million dollar budget for their single agency internal investigation (Chittum, 2013, para. 2).  Also, one key individual, Richard Bowen, claims that FCIC actively interfered with the candidness of his testimony, even requesting him to modify or remove information pertaining to damning information related to unethical, maybe even criminal, activity at Citi (Chittum, para. 12-14).

The subsequent Government response largely came in the form of Public Law Number 111-203, known as the Dodd-Frank Act (Block-Lieb & Janger, 2011, p. 698). The Act addressed predatory mortgages and practices, created a consumer financial protection agency called the Consumer Financial Protection Bureau (CFPB), and addressed, through creation or modification of law, regulation for the industry (Block-Lieb & Janger, p. 699).  Of worthy note is that fact that the Congress used considerable foresight in funding the CFPB through the Federal Reserve Board, thus effectively eliminating partisan political pressure through budgeting means (Block-Lieb & Janger, p. 700).

However, not all attempts at reform were successful. Some argue that the monetary bail outs did little more than promote, even reward, the very abhorrent behavior that precipitated the bailouts themselves (Watkins, 2011, p. 370).  Regulations require banks to secure more capital to guarantee performance, but do not address restrictions on how they raise such capital (Watkins).  Some of the same regulations do not go into effect until 2019, allowing current negative banking trends to continue unfettered (Watkins).

References

Block-Lieb, S., & Janger, E. (2011).  Reforming regulation in the markets for home loans. Fordham Urban Law Journal, 38(3), 681-719.

Chittum, R. (2013, September 23). New questions about the financial crisis inquiry commission.  Retrieved from http://www.cjr.org/the_audit/new_questions_about_the_financ.php.

Ecker, M.  (2007).  Art Explosion  800,000 [Software].  Calabasas:  Nova Development.

Financial crisis inquiry commission. (2011, march 10). Retrieved from http://cybercemetery.unt.edu/archive/fcic/20110310172443/http://fcic.gov/

Watkins, J. (2011).  Banking ethics and the goldman rule.  Journal of Economic Issues, 45(2), 363-372.  doi:10.2753/JEI0021-3624450213.

Social Responsibility

Tags

Corporate Governance: An International Review, Gilbert, Goldman Sachs, Mortgage loan, PBS, Subprime lending, University of North Carolina, Wall Street

As I discussed earlier, some study results may show a direct correlation between corporate board structuring and participation in subprime lending schemes.  Boards for lending institutions involved in subprime mortgaging generally contained members with substantially shorter time in office, younger member age, and displayed less member diversity (Muller-Kahle & Lewellyn, 2011, p. 411).  Essentially, studies show a correlation between shorter tenure with inexperienced, less diverse, board members and corporate participation in subprime lending (Muller-Kahle & Lewellyn, p. 413).  Such situations leads to the perfect application of the Goldman Rule, as Watkins ( 2011, p. 365) so eloquently writes, “the greater the profitable opportunities, the more likely individuals and organizations will engage in behavior without regard for the broader consequences”.

Lest we forget, the larger corporations are not immune from such problems.  The Securities and Exchange Commission (SEC) publicized documents in 2010 accusing against Wall Street giant Goldman Sachs of selling a “subprime-mortgage investment that was secretly designed to lose value” (Watkins, p.366).

Thus, we must now consider the concept of social responsibility, rather, lack thereof, when considering the subprime mortgage lending industry.  Social responsibility implies some sort of ethical contract between the agency and stakeholders.  Lenders placing profits above all other considerations violate this ethical contract.  The results include not only financial ruin for otherwise unqualified borrowers, but the deterioration of the communities in which they partake their business.  Banks owning properties in areas that will not sell for socioeconomic reasons, blighted properties from neglect to properly maintain and repair, and unfettered trespass for a myriad of nefarious means (Gilbert, p. 89).

All is not lost, however.  Other studies have shown promise in corporate embracement of new leadership strategies, being emotion regulation, self-reflection, forecasting, and information integration (Thiel, Bagdasarov, Harkrider, Johnson, & Mumford, 2012, p. 49).  These four strategies integrate common sense tactics, and financially reward those who adopt them (Thiel et al, p. 54).  Agencies must train responsible parties in these concepts, and further hold them accountable for their actions (Thiel et al, p. 49).

Part three will be coming soon.  Until then, I recommend reading the University of North Carolina report, and the PBS investigative report, “Blowing the Whistle on the Mortgage Bubble“.

References

Alvimann. (Photographer). (2010, January ). One_hundred_dollar_bills_8654(14) [Web Photo].  Retrieved from http://www.morguefile.com/archive/display/648418.

Ecker, M.  (2007).  Art Explosion 800,000 [Software].  Calabasas:  Nova Development.

Gilbert, J. (2011).  Moral duties in business and their societal impacts:  The case of the subprime lending mess.  Business & Society Review, 116(1), 87-107.  doi:10.1111/j.1467-8594.211.00378.x.

Khan, A. (2013, January 22). Blowing the whistle on the mortgage bubble. Retrieved from http://www.pbs.org/wgbh/pages/frontline/business-economy-financial-
crisis/untouchables/blowing-the-whistle-on-the-mortgage-bubble/.

Muller-Kahle, M., & Lewellyn, K. (2011).  Did board configuration matter?  The case of u.s. subprime lenders.  Corporate Governance:  An International Review, 19(5), 405-417.  doi:10.1111.j.1467-8683.2011.00871.x.

Subprime mortgage crisis. (n.d.). Retrieved from http://www.stat.unc.edu/faculty/cji/fys/
2012/Subprime mortgage crisis.pdf.

Thiel, C, Bagdasarov, Z, Harkrider, L, Johnson, J., & Mumford, M. (2012).  Leader ethical decision-making in organizations:  Strategies for sensemaking.  Journal of Business Ethics, 107(1), 49-64.  doi:10.1007/s10551-012-1299-1.

Watkins, J. (2011).  Banking ethics and the goldman rule.  Journal of economic issues, 45(2), 363-372.  doi:10.2753/JEI0021-3624450213.

Subprime Mortgages Revisited

Tags

borrower, Corporate Governance: An International Review, FICO, lender, Loan, mortgage, Mortgage loan, Muller-Kahle, risk, Robertson, San Jose State University, subprime, Subprime lending

Many of us remember seeing and reading media reports centered upon the then-emerging crisis over subprime mortgage lending.  Let us revisit the origins of the crisis, and the inherent risks.

One of the better definitions of subprime lending I have read is, “the act of offering financing to an individual with poor credit, low income, or limited documentation, who generally wouldn’t qualify for a mortgage at standard market rates” (Robertson, n.d., para. 1).  Generally speaking, a person possessing a Fair Isaac Co. (FICO) score at or less than 620 would only qualify for such a loan (Robertson, para. 4).

That meant borrower risks, potentially life-altering ones.  Subprime borrowers faced higher interest rates, often placing the borrower into debt loads that quickly became insurmountable (Watkins, n.d., para. 4).  Studies have shown that many of these at-risk borrowers belonged to a racial or ethnic minority, were low-income wage earners, or both (DeLoughy, 2020, pp. 585-586).  It is difficult to imagine that a person making low-income wages could afford exorbitantly high mortgage payments when they could not qualify for lower payments from more traditionally weighted loans.

Lenders were also not immune from risk.  A study from Lewellyn and Muller-Kahle (2012) indicated that entities dealing primarily in subprime loans lacked independent boards, with the boards possessing shorter member tenure than other entities.  The entities themselves also tended to be in business for shorter time spans then their contemporary counterparts (Lewellyn & Muller-Kahle, p. 298).  This combination of lack of corporate controlling oversight and inexperience lends itself to a great possibility for unethical actions.

In my next blog post, I will discuss some of these unethical actions, the leadership role in such actions, and how these acts relate to corporate social responsibility.  Until then, I recommend further readings from San Jose State University Professor Thayer Watkins, and thetruthaboutmortgage.com.

References

DeLoughy, S. (2012).  Risk versus demographics in subprime mortgage lending:  Evidence from three connecticut cities.  Journal of Real Estate Finance & Economics, 45(3), 569-587.  DOI 10.1007/s11146-010-9281-0.

Ecker, M.  (2007).  Art Explosion 800,000 [Software].  Calabasas:  Nova Development.

Lewellyn, K., & Muller-Kahle, M. (2012).  CEO power and risk taking:  evidence from the subprime lending industry.  Corporate Governance:  An International Review, 20(3), 389-307.  doi:10.111/j.1467-8683.2011.00903.x.

Robertson, C. (n.d.). Subprime lending. Retrieved from http://www.thetruthaboutmortgage.com/subprime-lending-and-subprime-lenders/.

Watkins, T. (n.d.). The nature and the origin of the subprime mortgage crisis. Retrieved from http://www.sjsu.edu/faculty/watkins/subprime.htm.