Since the collapse of the subprime market, there has been much discussion and study of the situation and outcomes. The impact to our economy was significant and several regulations were developed in order to prevent this type of demise to our housing and mortgage lending industries.
The Emergency Economic Stabilization Act (EESA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 were both designed to prevent a recurrence of the subprime mortgage crisis experienced in 2008. These acts were designed to resolve the financial crisis, minimize future taxpayer losses, and protect consumers. The EESA enabled the government to purchase the bad credit securities through the Troubled Assets Relief Program (TARP). This act also allowed for increased FDIC insurance to the financial institutions in order to assuage the customers fears looming with potential bank failures.
The Dodd-Frank Act was expressly written to protect the consumers by reestablishing regulations and oversight that were removed with the enactment of the Community Reinvestment Act of 1977. Its focus is on eliminating predatory lending, limiting a company’s options in trading within funds and includes the retention of risk on traded securities, and provides for transparency and accountability with oversight from the Security Exchange Commission.
While these two monumental efforts have done much to correct the economic situation created by the subprime mortgage lending market collapse. A new surge of subprime lending has emerged in the auto loan industry and the regulators are being tested. Aggressive sales tactics are now being applied in the form of car loan solicitations. The Department of Justice is responding with subpoenas and inquiries into General Motors and Sandtander Consumer USA for their questionable lending practices.
For all intents and purposes, it appears that the appropriate attention is being paid to the reemergence of abuses in the subprime lending industry. Actions are being taken in line with the laws and regulations emplaced in 2008 and 2010. With due diligence and a bit of luck, we should be able to prevent a repeat of the collapse experienced previously.
If a tree falls in the forest and no one hears it, did it make a sound? This is the same approach financial institutions are taking in regard to subprime lending. If a loan is given to the weakest borrowers and the lender no longer holds that loan, are they responsible for the default and the fall out that weakens our economy?
Financial institutions all claim to practice corporate social responsibility. Given this claim, should they also be promoting subprime lending? The answer is yes. Subprime lending is necessary to promote economic growth. However, in light of questionable ethics, a company could exploit the advantages of subprime lending in order to create greater commissions, which, per the Wall Street Journal were .04% higher on average than a conventional loan. As such, brokers could use aggressive sales tactics to sell subprime loans to borrowers who would otherwise qualify for conventional loans. The journal reported that between 2000 and 2007, more than 55% of the subprime loans went to people who could qualify for conventional loans. During this period there was clearly a gap in the mortgage brokers ethical compass.
With an eye on creating profits while eliminating risk, financial institutions adopted the “originate to distribute” model for loan products—basically loans are originated, then sold off as securities to investors (Gilbert, John 2011). Knowing that the total risk of the subprime loan would be transferred led to banks loosening their lending criteria. In contrast, Gilbert also points out that when the bundled securities were sold off, the investors were unaware of which loans were at risk creating an environment where the best answer is to say no to the investment. Ultimately this led the collapse of the subprime market in the last decade.
As banks eye other commerce markets for their subprime products, such as the auto loan industry, there needs to be a review of these lending institution’s published values in regard to their corporate social responsibilities. The need for socially responsible lending institutions is paramount to keeping us from plunging into another banking crisis. As borrowers scramble to fix their credit standing, subprime loans are again a sought after option. Without due diligence and strict oversight, the potential to further damage the economy looms in the balance.
Subprime lending is the vehicle used by financial institutions to conduct predatory lending operations. In layman’s terms, it is the art of helping people dig financial holes so deep that they cannot get out, while gaining profits at the demise of our economy. Between 1997 and 2005, subprime lending grew from $65 billion to $665 billion as financial institutions imposed abusive and unfair loan terms on borrowers while practicing aggressive sales tactics. The collapse of the subprime lending market is directly attributable to the risky lending behaviors of US banks in the home mortgage industry. As a refresher, subprime loans are offered to people who have substandard credit, are unable to produce a down payment, and/or have no reserve funds to qualify for a loan. This financial avenue perpetuates America’s propensity to buy on credit without regard to one’s ability to repay the debt.
Subprime lending gives a bye to the person who is in financial distress with a questionable financial history. Given that these same people are pursuing the loan due to some distressful situation needed to support their household, the requirement outweighs the more responsible behavior. This opens the door for more risky behavior by enabling the borrower to further overextend themselves and proceed further down the spiral of financial ruin. In attempts to use these loans to improve their tarnished credit, borrowers are going to great lengths to ensure they remain current on these loans by sacrificing basic survival needs for their families.
Leadership decisions within the banking industry to grant subprime loans emerge when greed trumps the greater good of providing ethical business practices that promote a stable economy. When financial institutions are driven by profits over everything else, they tend to take greater risk in lending money to their customers. They minimize this risk by bundling and selling off loans to investors who are looking for high yield returns. In essence, the financial institutions are creating a buffer and promoting deniability in the event of market collapse. John Watkins (2011) defines this in his article “Banking Ethics and the Goldman Rule” found in the Journal of Economic Issues, as the Goldman rule where organizations pursue profits regardless of the effects on others.
As if the housing debacle were not enough, lenders have targeted the auto loan industry as their next target. These acts further demonstrate how far we haven’t come.