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).
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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