Rebuilding trust and embedding the ethic of care in the subprime mortgage environment

Mortgage lenders have an ethical obligation to exercise an ethic of care with respect to subprime mortgage lending practices. This obligation involves duties to both consumers as well as shareholders, as lenders need to exercise due diligence to understand and evaluate clients’ reasonable ability to afford and repay subprime mortgage loans. Thus, mortgage lenders have fiduciary responsibilities to borrowers, organizations, investors, shareholders, and other stakeholders; thus trust is essential to how the subprime mortgage lending system functions.

Two critical fiduciary responsibilities lenders have towards borrowers are as follows: 1) Know your client; 2) Suitability. According to Sternberg (2013), lenders need to understand how the loan will be repaid, basic income and asset information, and evidence about a client’s creditworthiness. Also, lenders need to consider whether the mortgage loan is suitable given the client’s profile (Cushman, 2015). These responsibilities affect properly analyzing default risk, which then impacts placing clients in suitable loans given their profiles. Failing to profile or consider client suitability potentially increases default risk, as the client’s willingness, ability and intent to repay are unknown.

Subprime mortgage lending potentially overlapped with predatory lending practices during the housing bubble. A portion of subprime loans were disbursed even though borrowers’ willingness, as well as ability and intent, to repay the mortgage were uncertain (Sternberg, 2013).

[Untitled advertisement]. Retrieved April 25, 2015 from http://www.federalreserve.gov/newsevents/files/bernanke-lecture-three-20120327.pdf

Furthermore, fiduciary duties to the organization, investors, and stakeholders involves not only honest dealing, but also the proper loan structure to provide sufficient collateral to maximize prompt repayment in the event of a default (Gilbert, 2011). Thus, mortgage lenders should minimize default risk and promote accurate disclosure and transparency. According to Walter (2014), failure to minimize default risk not only results in potential losses for the organization, investors, and other stakeholders, but exposes the organization to fines, which further penalizes shareholders.

After the subprime lending crisis, several measures have been taken to mitigate subprime mortgage loan risks and encourage a more ethical lending environment. Measures addressed controls and accountability at the institutional, as well as organizational and institutional levels (Nielsen & Massa, 2013). These measures refocused the subprime mortgage system towards long-term sustainability, rather than excessive lending behavior generating short-term profitability.

Organizations took actions to improve their ethical organizational climate through training, development, improved controls, and accountability. Koller, Patterson, and Scalf (2014) stated that lending firms implemented new ethics training. Also, lending organizations made changes to their organizational culture to encourage personal responsibility and accountability in the lending process (Walter, 2014). These organizations also increased controls related to mortgage fraud and corporate compliance (Koller et al., 2014). Furthermore, appropriate barriers to internal and external communication were established to control conflicts and potential fraud (Walter, 2014).

Although slower, some institutional level changes have strengthened the subprime mortgage lending environment. Watkins (2011) explained that capital requirements from Basel 3 reduces lending institution’s leverage capital, potentially limiting excessive lending practices. Also, there is increased awareness and recognition of moral hazards within the subprime mortgage lending system, which then impacts individual lending analysis (Walter, 2014).

References

Board of Governors of the Federal Reserve System. (2012, Mar 27). The Federal Reserve and the Financial Crisis [Lecture 3: The Federal Reserve’s response to the financial crisis]. Retrieved from http://www.federalreserve.gov/newsevents/files/bernanke-lecture-three-20120327.pdf

Cushman, T. (2015). The moral economy of the great recession. Society, 52(1), 9-18. doi:10.1007/s12115-014-9852-4

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.1467-8594.2011.00378.x

Koller, C. A. Patterson, L. A. & Scalf, E. B. (2014). When moral reasoning and ethics training fail: Reducing white collar crime through the control of opportunities for deviance. Notre Dame Journal of Law, Ethics & Public Policy, 28(2), 549-578.

Nielsen, R., & Massa, F. (2013). Reintegrating ethics and institutional theories. Journal of Business Ethics, 115(1), 135-147. doi:10.1007/s10551-012-1384-5

Sternberg, E. (2013). Ethical misconduct and the global financial crisis. Economic Affairs, 33(1), 18-33. doi:10.1111/ecaf.12010

Walter, I. (2014). Reputational risk in banking and finance: An issue of individual responsibility? Journal of Risk Management in Financial Institutions, 7(3), 299-305.

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