Post 2 of 3:

Intermediaries in the secondary mortgage market that purchase loans from lenders have requirements or specifications that communicate what they will purchase/accept. This is important because the ability to turn around and sell a mortgage loan (rather than hold it) after underwriting it or providing it to a consumer, means that lenders would have less of an incentive to provide/underwrite quality loans.

There were some ethical issues with some of the loans offered. Some loan types such as “stated income” encouraged homeowners to be dishonest about their incomes in order to qualify for a loan. The financial institution did not verify or check the income noted in the application for a “stated income” loan. And, most of these “stated income” loans were classified as Alt-A loans (another type of loan considered to be loans of fairly high quality – just below prime loans or near-prime) if the borrower had a reasonable credit score.

Further, the fact that lenders (banks, mortgage brokers and other financial institutions) made the policy decision to “offer ARMs to applicants who can barely qualify at the initial rate, and who will probably be unable to meet their obligations if the rate increases in the future does present an ethical issue.” (Gilbert, 2011, p. 97) (emphasis added). The institutions advertised risky products to lower-income segments of the population such as blue-collar workers, high school graduates, and older people, and encouraged them to use the products although the products/mortgages were likely to harm them. Later, when a lot of these individuals had problem affording mortgage payments, they complained that the institutions did not adequately explain the details. This lending practice is known as predatory lending. Lenders were driven by the profit motive and did not always act in good faith.

However, subprime loans have also enabled “some borrowers to move beyond their credit-blemished past into homes” (Smith & Hevener, 2014, p. 323). A lot of Americans took advantage of low down-payment loans and other types of subprime loans to own a home. Banks therefore helped the community by providing loans to the underserved, meeting the requirements of the Community Reinvestment Act of 1977. This Act was seen as partially responsible for the subprime mortgage crisis.

Gilbert, J. (2011). Moral Duties in Business and Their Societal Impacts: The Case of the Subprime Lending Mess. Business & Society Review (00453609), 116(1), 87-107. doi:10.1111/j.1467-8594.2011.00378.x

Brauneis, M., & Stachowicz, S. (2007). Subprime Mortgage Lending: New and Evolving Risks, Regulatory Requirements. Bank Accounting & Finance (08943958), 20(6), 28-34.

Leonhard, C. (2011). Subprime Mortgages and the Case for Broadening the Duty of Good Faith. University Of San Francisco Law Review, 45(3), 621-654.

Ross, L. M., & Squires, G. D. (2011). The Personal Costs of Subprime Lending and the Foreclosure Crisis: A Matter of Trust, Insecurity, and Institutional Deception. Social Science Quarterly (Wiley-Blackwell), 92(1), 140-163. doi:10.1111/j.1540-6237.2011.00761.x

Smith, M., & Hevener, C. (2014). Subprime lending over time: the role of race. Journal Of Economics & Finance, 38(2), 321-344. doi:10.1007/s12197-011-9220-9