The Subprime Mortgage Crisis

Ethical Issues behind the Subprime Mortgage Crisis

            Loans in the US are categorized as either prime or subprime in accordance to the borrower’s credit. Subprime mortgages tend to have higher interest rates as compared to the prime ones due to their high default rate. The subprime mortgage crisis was triggered by the housing bubble burst, which occurred when speculative forces in the housing market arose due to low interest rates causing a rapid rise in the housing prices. The effects of this phenomenon were felt on a global scale especially by homeowners (borrowers), financial lenders (banks and other financial institutions), mortgage brokers and credit card holders (Ventolo & Williams, 2008).

With the onset of the millennium in 2000, an escalation of real estate values occurred in the state due to the availability of cheap and affordable credit caused by a reduction in the interest rates by the Federal Reserve. Homeowners and real estate investors resorted to buying house properties on a large scale through the much available capital and home ownership rose by 69%. Due to this, financial lenders were at ease in giving out the loans to those individuals who had no homes of their own because their poor credit portfolios had barred them in the past from earning a mortgage. With the houses serving as collateral, many buyers applied for the mortgages since they knew that in the face of any financial strain, they could sale of their homes and pay off their debts. When the housing bubble burst, need arose for the selling of the houses in order to service the mortgages. Selling of houses was very hard due to the flooding of the market, which brought along with it the subsequent drop of prices and value of the property. Refinancing was difficult and most of the clients were incapable of repaying their mortgages on time accelerating the pace of foreclosures in the last quarter of 2006.

The type of loans that they had picked also contributed very much on the financial crisis effects that they faced. Homeowners who chose the adjustable rate mortgage (ARM) were most affected since they constituted 80% of the total homeowners. ARMs are a type of loan whose interest rate is adjusted periodically and the first two or three years are fixed with the adjustments beginning there after. The advantage is that the rates are that the initial rates are usually fixed on a lower rate than that of fixed rate traditional mortgages. In the interest-only ARM, a borrower is only entitled to the payment of interest on loan exclusive of the principle amount for the initial stages of the loan. The payment-option ARM allows the borrower to choose the amount he wants to pay for each month (Rains, 2008).

With the increment of the interest levels, interest levels tended to rise to double levels meaning that the borrowers had to pay double of what they owed the lenders. Ironically, what they had previously dismissed as being expensive turned out to be the better deal (fixed mortgage). Logically speaking, this was huge financial loss on their part but for those who were prudent enough to choose the traditional way, no loss occurred to them. Selling of the houses also did not provide a feasible solution because the fall in the value meant that one also had to sell at a loss. Either way, the loss was inevitable. Sadly, those who could not afford to pay for the loans had to leave their homes, forcing them to look for alternative residential places that were cheaper or if they could not afford this, with family or friends. Annual Percentage Rate (APR) of charge was also increased to meet the losses that were being experienced and this too affected the investors negatively. Potential buyers and investors temporarily kept away from the market by the disillusion that they got. Real estate managers and participants also noted a dramatic fall in purchases leading to losses being recorded.

Most banks and financial institutions that advanced the loans were evidently affected. The financial turmoil that was created in the US subprime mortgage market saw the New Century Financial Corporation, the second largest subprime mortgage lender and a few others file for bankruptcy protection. Those financial institutions that did not opted to change their subprime mortgage credit to securities and sold them to investment bodies with the aid of agencies. Though these may appear to be the most affected player in the field, looking at the whole matter from a wider sense shows that almost every one is affected, whether directly or indirectly. Other bodies in the housing industry like homebuilders, mortgage brokers, proprietors and tenants, mortgage enterprises and others will be affected in one way or another. The decline of the economy is most likely to affect taxpayers and stock market. Laid off workers and homeless citizens who have been affected directly by the crisis are likely to become a liability to someone else and in that way affect them. Note that, these effects are also felt globally through the rippling effect but only on a softer note.

Assessing the situation today, the effects are still looming at large and the current laws have a lot of work to be done on them for analysts believe that they are still incapable of preventing another repetition occurring. Better and improved regulations and standards need to be enacted in laws concerning lending procedures and practices especially in the setting of clear and defined guidelines in the housing sector (Rains, 2008). Laws stipulating relationships requiring the lender to inform the buyer truthfully on the terms and conditions of loans should be enacted with the penalties that can be taken on the breach of such. Some resolutions and checks have been put to place while others have been proposed.

Actions that have been taken to deal with the situation in the banking sector have been formation of a partnership among different central banks around the globe in a bid of coming up with different strategies to deal with the situation. Federal funds were lowered to 2% while the open market operations to ensure liquidity are maintained at a suitable level. Central banks lowered their interest rates to make credit available to the commercial banks in order to revive them again from the crunch. A number of lending facilities were created to enable the Federal Reserve to advance loans too to the commercial banks and other lending institutions. The government also gave up some funding to help the most affected homes that either have been closed or are threatened with foreclosure in cost sharing the payment. With over 250 mortgage cases having been reported with connection to the subprime mortgage crisis, the US Federal Bureau of Investigation launched investigations on some mortgage financing companies to look into possible cases of fraud. The Federal Bureau of Investigations also increased the number of agents in a nation wide investigation concerning lending and borrowing mortgage fraud instances.

Economists have given a number of proposals to help with the current crisis and to prevent a recurrence. Procedures should be put in place on how financially crippled lending institutions could be dissolved and the minimal leverage for all the institutions should be put in place. Early warning systems should be established to check on systematic level of risks and act as indicators for any looming levels that may be disastrous. The lending institutions should be controlled in some areas to discourage them from being inactive or falling in the same trap again. Ensure that the lending institutions are well able to support the load that they pick upon themselves comfortably as well as insist on some down payment from mortgaging companies and verification of income and assets to avoid fraud (Ventolo & Williams, 2008).

Mortgage brokers should be charged with a significant level of responsibility and accountability system restricting them to conducting an acceptable and truthful job to their clients. Perhaps an operating license would be a good idea to act as a check on their performance levels and should be liable to being revoked once malpractice and unlawful actions occur. Rating agencies should disclose the exact parameters that they are testing at any time and in addition to credit ratings that they investigate, they should also include market and liquidity risks as well. Some proposers feel that risk assessment and creation of reserves have proven that they are inadequate checks when it comes to the issue of liquidity hence a proper management system using international standards should be introduced for both local and international markets. This should not prove as a hard task to implement because of the unity that had already been created by the central banks.

Most citizens feel that since the crisis touches on most people around the world, the government should create transparency channels of informing the people of the progressiveness in solving of the crisis because it will take quite a while in solving it and the matters arising. However, reviews done on June 2009 on these issues have shown that most of the many proposed solutions have not been implemented. Factually, this is the most important phase of any kind of problem solving because without it or with poor implementation, nothing is solved. The government is to ensure therefore that the remaining important parts of the proposals that have not yet been implemented are rightfully tackled and within the proper time limit. With this, citizens and the media can act as very good checks in keeping the government accountable for its actions.

As for now, the credit crisis has been somehow checked by the lending practices that the central bank and Federal Reserves undertook but much has still to be done. The implementation processes of the proposals leaves much to be desired but should be done on a little by little basis. Hopefully, both the US and global economy should be back on business within no time if all rules are properly adhered to.

 

 

 

 

 

 

 

Source: Farcaster. U.S. Federal Reserve. Chattanooga, TN: University of Tennessee at Chattanooga, 2008

 

 

Source: Farcaster. U.S. Census Bureau State of the Nation’s Housing Report 2008. Cambridge, MA: Harvard University, 2008.

 

 

 

 

 

 

 

References

Ventolo, W. & Williams, R. M. The Art of Real Estate Appraisal: The Complete Guide for Homeowners and Real Estate Professionals, New York: Kaplan Trade Series, 2008

Rains, R. Little Black Book of Wealth Building Mortgage Secrets: Insider Strategies for Securing a Stable Mortgage and Avoiding Common Pitfalls in Any Market, New York: McGraw Hill Professional, 2008

Source: Farcaster. U.S. Census Bureau State of the Nation’s Housing Report 2008. Cambridge, MA: Harvard University, 2008

Source: Farcaster. U.S. Federal Reserve. Chattanooga, TN: University of Tennessee at Chattanooga, 2008