Anytime something goes wrong, it is only a matter of time before the blame-game starts. With the events of the recent sub-prime mortgage crisis, there is no single person or entity that can solely be blamed for this misstep in society. Alternatively, it was a combined effort from the potential and current homeowners, lenders, underwriters, and investors. In a 2009 CBS newscast, and even still today, we hear about investment banks’ balance sheets being filled with “toxic assets” (sub-prime mortgages), which is one reason why they are incapable of loaning to businesses and individuals.[i] The CBS news reports also explains how the Obama administration is coming up with a plan to purchase up to $1 trillion worth of toxic assets from struggling banks to help clean up their balance sheets. However, many individuals are clueless as to what these toxic assets are, why they have such a huge impact on the U.S. economy, and who is genuinely at fault. This essay will explain who or what should be at fault for the sub-prime mortgage crisis. As part of my ethical framework, I will connect the two concepts of time and justice and implement deontology theory into my argument to see what could have been done differently.
To begin, after watching a CNBC documentary film a fellow colleague sent to me called the “House of Cards,” I noted that the major causes of the sub-prime mortgage crisis were due to the following circumstances: the ups and downs of the housing market, predatory lending strategies, inaccurate credit ratings, securitization, and the permissive policies of the central banks.[ii] Massive inflows of foreign capital and low interest rates developed easy credit conditions for many years leading up to the sub-prime mortgage crisis.[iii] The sub-prime mortgage crisis began in 2007 when a loss of confidence in securitized mortgages resulted in a liquidity crisis. To calm this liquidity issue, the U.S. Federal Reserves decided to pour substantial amounts of capital into the markets. As a result, we have lost billions of dollars, companies that were sustained for over a century are gone, and people are losing their families, jobs, homes etc. How did all this happen?
The sub-prime mortgage crisis was not only because Wall Street went broke; it was not because the economy was suffering; it was merely the players in the “house of cards” who did not understand that their decisions were incredibly damaging to our economy. The house of cards is an overly complicated, weak structure or organization that has the potential to fail at any point in time. The faulty foundation of this house of cards was comprised of mortgages. The mortgage process goes as follows: an individual searches to find a home that fits the budget, and then seeks a mortgage to help pay for the house. Americans have been doing this for years without any problems. So what went wrong with sub-prime mortgages and what questions does it have to connect with ethics?
As I mentioned above, the concepts of time and justice along with deontology theory make up the ethical framework of this essay. Deontology theory and A Kantian approach to business ethics, by Norman E. Bowie are not directly tied to finance specifically. However, I will apply his fundamental concepts to the sub-prime mortgage crisis. Deontological theory simply states that, “people should adhere to their obligations and duties when analyzing an ethical problem regardless of the consequence.”[iv] In other words, a person should do what is right because it is the right thing to do no matter what the outcome presents. Now let’s look at how the connection between time and justice relates to the sub-prime mortgage crisis.
One of the major shortcomings that led to the sub-prime mortgage crisis was time. Managers, investors, banks, and predatory lenders were focused solely on short-term, quarterly earnings and completely disregarded strategy, fundamentals, and conventional approaches to the creation of long-term value. Is this action justifiable? According to the article “Overcoming Short-termism,” published by the Aspen Institute, in the United States, we believe a healthy society requires healthy companies that effectively pursue long-term goals. The American Dream is this belief, which allows U.S. citizens and current residents to achieve their goals through hard work.[v] In other words, one’s prosperity depends on one’s own ability and hard work. What happened to the integrity of the American Dream? Hard work pays off right? For most, prosperity or success does not happen overnight. Reaching success is a process that takes time, dedication, and hard work to build something sustainable. Therefore, focusing on short-term gains is unjustified based on the criterion of our country’s overall strategy and outlook. We can use the ethical framework provided by the concepts of time, justice, and deontological theory to evaluate who is at fault for the sub-prime mortgage crisis.
First and foremost, for an individual to borrow money with no intentions of paying back is wrong. It is like borrowing money from a friend with no intentions of paying them back.[vi] The action is unethical and does not make sense. For example, using Kantian ethics, if I cannot keep my own promises, how can I expect others to?[vii] When an individual takes out a mortgage for a home knowing they cannot meet the payments based on the terms of the mortgage, they are doing something unethical and they are not living up to their side of the commitment. Obviously, if everyone who took out these mortgages were able to continue making payments on them we would not have had this financial crisis. However, not every individual is rational and we have to think realistically. Therefore, the reality is that people are defaulting on their mortgage payments so the value of these mortgages has been lost causing the financial crisis we see today. However, let us not solely blame the people taking out mortgages, since there is plenty of blame to give out.
What about the mortgage brokers or bankers who ultimately issued the loans to people with poor credit and high risk of default? Yes, the predatory lenders actions were improper while searching to make a quick buck. In my opinion, they were the biggest culprits. For instance, people expect the broker or banker to tell them that they cannot get a particular loan if they will not be able to pay for it; this action is implied! Why would a person think that a lender would issue a loan knowing the applicant would default? In other words, people think of mortgage brokers or bankers as a “gatekeeper” who will only let them in if they are able to meet the payments based on the terms of the mortgage.[viii]
In defense for the lenders, one might argue that there was huge demand for mortgages, and housing prices were quickly rising because interest rates fell substantially. During this time, lenders could have seen these sub-prime mortgages as a lesser risky investment then they really were. This is because rates were extremely low, the overall economy was doing well, and people were making their payments on time.
The gatekeeper methodology eventually failed because people were getting loans with no proof of assets or verification of a stable income.[ix] If the potential homeowner said they could make the payments then they were granted the loan without question. The reason for the collapse was that the gatekeeper was incentivized to let people through the gate, no matter what their financial stability entailed.[x] As mortgage brokers became a “yes-or-yes” player who did not have a vested interest in whether or not the person applying for the loan could pay for it or not, they simply stretched the limits.[xi] In other words, when they were given a finger, they took the whole hand! Using two formulations from Kant’s perspective, (using people as a means to an end and the concepts of lying and deception), let us see where the mortgage brokers actions were unethical and unjust to the consumer.
First, the action of selling a product or service to someone who cannot afford it is unjust and unethical to the person applying. For example, looking at Kant’s second formulation which basically explains that “we should not use people as a means to an end,” Kant would argue that mortgage brokers knew that they were considered a gatekeeper and have a responsibility, whether incentivized or not, to do the right thing for the person applying for the mortgage and the lender they represent.[xii] In other words, it was the mortgage broker’s duty to represent the applicant and it was unjust to the lender to let incentives be the motivating factor in performing unethical practices while under this “moral contract” with the applicant.
Second, Kant’s view is that lying and deception is always wrong, regardless of the circumstance.[xiii] With that being said, the broker’s excessive hunger for their quick commissions trumped their integrity as some mortgage brokers or bankers were falsifying information on mortgage applications to allow the applicant to be accepted. In some cases, they also convinced people seeking mortgages to take out loans in higher amounts to increase their commissions to ultimately reap the benefits of these fast short-term gains. So now one may ask where is Wall Street in all of this controversy.
In the 80s and 90s, much of the home loans in the U.S. were made up of savings (bonds) and other loans. However, after the savings and loan crisis of the 1980s and 1990s, Wall Street became a large participant in home mortgages. Home loans were becoming securitized by these investment banks, which meant that loans and savings were being put together and sold as a package to investors.[xiv] Also, with fixed income investments (bond and notes), where annual returns on investments (yields) were extremely low, investment banks came up with a way to remove yields from these packages of mortgages that would induce investors looking for a substantial, and relatively quick method of income.[xv] How did they do it? In a 2008 newscast called, “Global Pool of Money Got Too Hungry,” former Morgan Stanley Investment Consultant, Mike Francis explains how they basically used their magic and brains to formulate a variety of mortgage pools creating riskier investment products while knowing that the mortgage pools themselves were very risky.[xvi] Even if they were given credit ratings that were not appropriate for the nature of the risk of these investments, these bankers on Wall Street knew that they had created more risk and they were selling the risk to the investor, which is called moral hazard. Thus, from Kant’s viewpoint without full transparency of the likelihood of default on these risky assets the action or motivation to sell them to investors was deceptive business practice.
Although the assets themselves were extremely sophisticated and complex, the problems with justice and deceit were explicit. Kant would argue that: 1) putting together extremely risky investments, 2) making them appear less risky then they really were, and 3) selling them to sophisticated, rational investors was still considered unjust and deceitful business. In other words, if the investors were truly aware of the full risks of these investments they would have been less proned to purchase them. As I mentioned above, the action of lying and deceit through Kantian ethics is unacceptable regardless of the circumstance. Kant would also argue that the investment banks motivation for creating these investments while making the risks involved non-transparent was deceptive and shows the greed for the quick fees and commissions they were making. In other words, the banks were using the investors as a means to an end to make quick fees and commissions.
In short, there were a mix of individuals and institutions who all contributed to the sub-prime mortgage crisis. More specifically, there was a group of people who should not have had or sought to purchase these mortgages. Next, there were mortgage companies and investment firms whose financial magicians thought of everything except the negative impact of their actions on our economy. Finally, there was a shaky house built of cards on Wall Street that lowered the standards of proof of income and assets to help fund their creative and complex investment products. As far as the concepts of time and justice, these two played a key role in the sub-prime mortgage crisis. It was a collective effort from homeowners, lenders, banks, and investors all looking for short-term satisfaction. With respect to the U.S. strategy of a long-term approach, these players’ actions and decisions to capitalize on the short-term gains were unjust. From top to bottom, the primary cause of the U.S. sub-prime mortgage crisis was a series of poor ethical and unjustified decisions by all participants, not just Wall Street or homeowners themselves. As expected, the house of cards has completely fallen apart, and we, the American taxpayer will be financially responsible for their ill-advised decisions. With respect to ethical relativism, mentioned in the Bowie article, everyone needs to understand that unethical and unjustified decisions by these companies who have financial control over our economy can have an incredibly damaging impact on our society.[xvii] With this ethical framework that I portrayed throughout the essay, it is evident that those players and homeowners were not adhering to the long-term strategy of the United States as they focused on maximizing their short-term satisfaction and quick profits.
[iii] http://digitalcommons.ilr.cornell.edu/key_workplace/600/ (Mark Jickling-Congressional Research Service-Causes of the Financial Crisis pgs. 5-10)
[vi] Norman E. Bowie, A Kantian approach to business ethics. Pg. 4
[vii] Norman E. Bowie, A Kantian approach to business ethics. Pg. 4
[viii] Susan Block-Lieb and Edward Janger. Demand-Side Gatekeepers In the market for Home Loans Temple Law Review: pg.466
[x] Susan Block-Lieb and Edward Janger. Demand-Side Gatekeepers In the market for Home Loans Temple Law Review: pg.474
[xi] Susan Block-Lieb and Edward Janger. Demand-Side Gatekeepers In the market for Home Loans Temple Law Review: pg.474
[xii] Norman E. Bowie, A Kantian approach to business ethics. Pg. 7
[xiii] Norman E. Bowie, A Kantian approach to business ethics. Pg. 5
[xiv] Mark Jickling-Congressional Research Service-Causes of the Financial Crisis pg. 2
[xvii] Norman E. Bowie, A Kantian approach to business ethics. Pg. 14