Role In The Subprime Market
Role In The Subprime Market
Ethics plays an essential role in the subprime market as it ensures businesses operate ethically. It ensures businesses and business owners do not engage in unethical practices that affect consumers and the industry. Subprime mortgage brokers should behave ethically and promote ethical business practices to ensure the lenders and debtors are not affected. The brokers should determine the ability of the borrower to repay so as to prevent the collapse of the subprime mortgage market. However, this was not the case in 2007. The subprime market grew rapidly from 2000 to 2007. Subprime mortgage brokers made a lot of money without following the appropriate procedures as evidenced by Kal Elsayed. Kal enjoyed of the benefits of the expansion of the subprime market. The market grew from $100 billion to $600 billion between 2000 and 2007( Giovanni, Igan & Laeven, 2008). The success of the subprime market was risky for the lenders and borrowers. Though people benefited from the growth, the loans offered proved risky for the lenders as companies gave loans to people who did not meet the standards.
The mortgage brokers did not consider the ability of the borrowers to repay the loans, or whether they met the standards governing the provision of loans. People should have high income to get loans. Also, subprime loans need big down payments. Some of the mortgage brokers lowered the credit score of the debtor in order to give then many loans. For instance, countrywide Mortgages lowered the credit score for the debtors from 700 to 650. Also, the company did not verify income and other information provided when applying for a loan online. The relaxation of the standards increased the number of mortgage brokers who focused on processing many loans using a similar applicant. Most of the brokers did not follow the rules governing the provision of loans. Countrywide hired Mr. Partow though he had been accused of lending abuses in Wisconsin. Mr. Partow processed several loans using Agin Delolli details. He submitted an application for Agim Delolli loan amounting to $295,000 and another one $202,500. The applications had different income and business details. Mr. Partow was sentenced for mortgage fraud, but countrywide had numerous buyers who did not meet the standards. Therefore, Mr. Partow did not act ethically as a broker as he did not verify the ability of the borrower to pay and also get the 10% down payment. He provided loans to customers who did not qualify. Isolation of individual ethical choices results to poor decisions and affects the market (Giovanni, Igan & Laeven, 2008).
Incentives have an impact on lenders and the products they offer to potential borrowers. Incentives affect lending decisions among lenders. Incentives have the capability to change how lenders make decisions and perceive reality. This was exemplified before the 2007 financial crisis. Lenders provided a wide range of incentives to buyers and affected them. The lenders approved loans that were not successful. The lenders focused on quantity instead of quality. The lenders were motivated by various incentives such as bonuses. The lenders did not consider the quality loan products they offered to customers, and this affected them negatively. They did not determine whether the loan products were successful or had a positive effect on the market or not. Instead, the lenders focused on giving more loan products to customers. The lenders targeted on having many borrowers. Therefore, the lenders did not pay attention to the credit history of the borrowers. The lenders rarely examined the ability of the borrower to repay the loan, and whether the borrowers met the standards. This in turn, affected the lenders as they incurred huge losses in 2007 as the borrowers did not have the capability to repay their loans. Thus, incentives changed their perception about the loan products they offered and the lending process(Gramlich, 2007).
A subprime mortgage is a kind of loan given to people with poor credit history. Subprime mortgage is given to people with a credit history below 600. Many people with credit history below 600 do not qualify for traditional mortgages. Subprime borrowers present a greater risk for lenders, and hence subprime mortgage charge higher interest rates than prime lending rates. There are different types of subprime mortgage structures. The most popular one is the adjustable rate mortgage (ARM). The adjustable rate mortgage charges fixed interest rates and then changes to a floating rate depending on an index like LIBOR, plus a margin. The most common kinds of adjustable rate mortgage are 3/27 and 2/28. Adjustable rate mortgages are misleading to subprime borrowers as at first they pay lower interest rates. The mortgage payments increase considerably when the mortgages rise to higher variable interest rates.
Though subprime mortgage assists people with a poor credit in getting loans, it has a negative effect on the subprime market and financial market. The subprime lending led to the 2007-2009 financial crises. Mortgage lenders relaxed underwriting standards due to competition between the lenders. The lenders competed for market share and revenue. Government sponsored enterprises maintained tight underwriting standards in 2003. Most investment banks and Fannie Mae relaxed their standards in order to compete with private financial institutions. The financial institutions, investment banks and government institutions, did not follow the appropriate standards when providing loans to customers. The institutions did not scrutinize the credit history of the customers well and instead gave loans to customers with poor credit history. The institutions concentrated on providing more loans to customers in order to increase their market share and remain competitive (Gramlich, 2007).
This led to a speedy increase in the number of subprime mortgage foreclosures in 2006. Thus, this caused the subprime mortgage meltdown. Most lenders were liberal when giving loans to customers between 2004 and 2006. This is because of the lower interest rates and high capital liquidity. Lenders focused on making profit by giving high risk loans to customers. They charged an interest rate higher than the prime so as to compensate to the extra risk they assumed. The lenders experienced extremely financial challenges after the number of subprime mortgage foreclosures increased. Some of the lenders became bankrupt. Proper measures should be developed to govern the subprime mortgage and hence prevent a crisis. Lenders should be careful when lending to borrowers to ensure they do not make risky decisions that could affect the industry (Zandi, 2009).
The recent financial crisis has put the subprime mortgage market on the spotlight. The subprime mortgage market expanded greatly before the 2007 financial crisis. It evolved from a small industry to a large industry in the country. It also evolved greatly to one of the major parts of the mortgage market in the country. The expansion of the subprime mortgage market was accompanied by deterioration of the credit standards and risk taking. Lenders took risks when lending loans to customers. It also led to obvious mortgage fraud as individuals used unethical business practices to increase their market share and profit. The expansion was due to the increase in competition and financial innovation. Also, loose monetary standards led to the expansion. As a result, lenders gave loans to customers with low credit scores and led top increase in subprime mortgage foreclosure as they could not pay the loans. This in turn, causes collapse of the sub mortgage market, stock market and affected the financial industry. There were various stakeholders between the relation between borrowers and lenders. That is the mortgage brokers, investors, credit rating agencies, government, Federal Reserve and bank regulators. The stakeholders had different functions. The mortgage brokers provided loans to borrowers. They used unethical practices to provide subprime loans to customers and this affected the subprime industry leading to financial crisis.
The government is responsible for monitoring the subprime mortgage lending and industry by developing legislation. Companies and individuals operating within the industry should follow legislation governing subprime mortgage lending. The government legislation governing lending was not followed as individuals used unethical business practices. The credit rating agencies determine the credit worthiness of customers and their capability to pay loans. The credit rating agencies did not rate borrowers as expected and hence lenders gave loans to borrowers who could not pay. Bank regulators regulate lending to borrowers. Bank regulators did not regulate the lending process and lenders used unethical practices. The increase in subprime mortgage foreclosure affected investor’s confidence and the rate of investment declined. Therefore, the stakeholders played a vital role in crisis as they did not act as expected (Gramlich, 2007).
Reference
Giovanni, D., Igan, D., & Laeven, L. (2008). Credit booms and lending standards. International monetary fund
Gramlich, E.M. (2007). Subprime mortgages. The Urban Insitute
Zandi, M.M. (2009). Financial shock. FT press
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