Subprime Loans

What are Subprime Loans?
Subprime loans are offered to individuals who tend to have a poor credit history, first time borrowers, and low income which can provide a greater risk for lenders. The rates for these borrowers are higher and usually for an extended period of time than what the prime rates offer. Due to the rapid growth, the United States subprime mortgage market was viewed as an essential part of this epic disaster over time. It was the banks and loan officers that provided credit to individuals who were not considered creditworthy (Markarov & Plantin, 2013) -- unreliable borrowers!

Click on the video below to watch a brief explanation of subprime loans, and how they negatively impact the economic world -- known as the "Credit Crunch".

https://www.youtube.com/watch?v=wGxmgwUWNr0&feature=youtu.be

Making predictions, can be difficult because you never know what the future has in store; no matter if it is a medical, business, or personal matter, many predictions can be inaccurate (Diekmann, 2007). As the video stated, bankers felt the housing market would rise as time went on, but they were definitely mistaken.

Risks Involved for Lender and Borrower 
Lending money to individuals without a job or anyone who cannot afford a specified monthly payment should not be given money to spend.  It is reality that individuals in this type of situation will not be able to pay their bills in a timely fashion, and will eventually run themselves into the deep-end with overdue bills and an enormous amount of debt. The banks and loan officers are taking a huge risk when lending money to people with poor credit and irresponsible spending habits. These individuals will more than likely find themselves drowning in a pile of debt, which will lead to banks repossessing their borrowed loan items, such as an automobile or house. An individual's low credit scores and savings will reduce his/her chances of qualifying for prime products (Richter, & Craig, 2013). This will decrease their reputation and credit history when trying to buy anything again with credit. 

Role of Leadership in the Subprime Loan Financial Crisis
Gilbert (2011) stated there may have been many culprits to a loan not being justified correctly when filling out and approving the loan application. Below are just a few of the decision-making processes that may have contributed to a subprime loan financial crisis:

* Borrowers, may have lied to lenders on their applications to get approved for a loan
* Mortgage brokers and lenders, who may not have asked or clarified the right questions or justified the questions to make sure they were accurately answered
*Investors who purchased these products without really knowing what they were buying

By 2008, in the wake of downward spiral in house prices, a full 45 percent of subprime borrowers were drowning in debt, causing outstanding subprime mortgages to go into default (Gabriel, Kahn, & Vaughn, 2015). John R. Commons was a man who expressed a high degree of optimism, and expanded public powers to balance the growing economic power of financial and industrial ongoing concerns (Ashton, 2014). Commons' work on the relationship of economic value helps us to interpret the problematic analysis of financial democracy and the legal issues taking place in the subprime lending crisis situations of the world today. Gilbert (2011) argued leaders must do the right thing morally, and if their actions hurt the organizations then they have failed to do their jobs.     

 The decision-making in the subprime loans were merely focused on rewards and profits of the lenders, rather than the outcome regardless of the risks involved associated with the transactions (Lewellyn, & Muller-Kahle, 2012). This resulted in ethical decisions being made. Were the banks and loan officers being greedy? They initially gave money to unreliable borrowers so that the banks could make a profit. The banks took for granted that the housing market would always go up. But in time, more than one-fifth of the 3.6 million loans outstanding were delinquent by the end of 2007 due to bad loan establishments (Gilbert, 2011).  

Subprime Notion of Social Responsibility 
An important aspect of Corporate Social Responsibility (CSR) is how an enterprise interacts with their internal and external stakeholders (Wu, & Shen, 2013). Effective management results in better performance, and higher success rate of the business. Companies are dependent on stakeholders to gather the required assets for their development and survival in the business world (Wu, & Shen, 2013).

The corporations were indifferent in regards to their social responsibility with their internal and external stakeholders, such as customers, investors, and shareholders in the way they administered subprime loans. The actions taken were consistent with the Goldman rule which focuses on the financial gains at the expense of their customers and society (Watkins, 2011).  

The impact on society lies in the hands of leadership and their meager ways of making decisions. Societies predict that companies will act socially responsible for their actions. Unfortunately, this doesn't always happen that way. Lending institutions are driven by their desire to make a profit at any cost, which can lead to unethical business practices. This is where the notion of social responsibility becomes a huge concern. One of the many famous CSR critics, Milton Friedman stated in his 1970 essay on the social responsibility of corporations, that the shareholders' duty was the main reason why a precise focus on profit maximization is the sole responsibility of corporations (Glac, 2014).

Lessons Learned from Subprime Loans
Many banks and lending institutions have tightened their mortgage loan qualification requirements after the mortgage crisis of 2008. In today’s home mortgage environment, lenders are becoming more rigorous and stringent when underwriting the loan process, in order to eliminate and deter the delinquencies and foreclosure rates. As a result, most banks and lending institutions have severely limited new loans to only those most qualified individual(s). The tighter the lending market becomes, the more frustrating circumstances for potential customers and current customers who need to refinance will be. Due to the fact, they will more than likely not be able to meet the stricter loan standards in today's market.

For those in the banking industry, whose ethics play a prominent role; really need to tighten their corporate behavior and lending practices to pursuit values of social responsibility. According to John (2008) new measures are intact by the Federal Reserve to assure that the subprime lending crisis mess does not happen again. The Federal Reserve called for the credit rating agencies to improve their way of grading an individual's credit report; in hopes to increase the economic outlook on our future generations, and create a more practical society.

References

Ashton, P. (2014). The evolving juridical space of harm/value: Remedial powers in the subprime mortgage crisis. Journal of Economic Issues (M.E. Sharpe Inc.), 48, 959-979. doi: 10.2753/JEI0021- 3624480405

Diekmann, A. (2007). Not the first digit! Using Benford’s law to detect fraudulent scientific data.  Journal of Applied Statistics, 34, 321–329.

Gabriel, S. A., Kahn, M. E., & Vaughn, R. K. (2015). Congressional influence as a determinant of subprime lending. Journal of Housing Economics, 2891-102. doi:10.1016/j.jhe.2015.01.002

Gilbert, J. (2011). Moral duties in business and their societal impacts: The case of the subprime lending mess. Business & Society Review, 116. doi:10.1111/j.1467-8594.2011.00378.x

Glac, K. (2014). The influence of shareholders on corporate social responsibility. Economics, Management & Financial Markets, 9(3), 34-72.

John, D. C. (2008). Preventing the next subprime crisis. The Heritage Foundation, 1862. 

Lewellyn, K. B., & Muller-Kahle, M. I. (2012). CEO power and risk taking: Evidence from the subprime lending industry. Corporate Governance: An International Review, 20, 289-307. doi:10.1111/j.1467-8683.2011.00903.x

Makarov, I., & Plantin, G. (2013).  Equilibrium subprime lending.  Journal of Finance, 68, 849-879.  doi: 10.1111/jofi.12022

Richter, F. G., & Craig, B. R. (2013). Lending patterns in poor neighborhoods. Journal of Economic Behavior and Organization, 95197-206. doi:10.1016/j.jebo.2013.03.005

Watkins, J. P. (2011). Banking ethics and the Goldman Rule. Journal of Economic Issues (M.E. Sharpe Inc.), 45, 363-372. doi:10.2753/JEI0021-3624450213

Wu, M., & Shen, C. (2013). Corporate social responsibility in the banking industry: Motives and financial performance. Journal of Banking and Finance, 373529-3547. doi:10.1016/j.jbankfin.2013.04.023