The 2008 Mortgage Crisis
During the late 1990s and early 2000s, the American economy was robust. It was fueled by an overheated housing market with creative lending products like adjustable rate mortgages, no document loans, and home equity loans. Many of the mortgages were subprime mortgages lent to borrowers who had issues regarding poor credit history, suspect employment history or other factors which would negate them receiving a traditional mortgage. Banks would lend to individuals who were more at risk and potentially unable to repay the loan. These subprime loans would ultimately jeopardize the entire banking system and global economy. Business professors Svesson and Wood provide a helpful framework when considering the ethics of the financial crisis. In their ethical business model, the interconnected subcomponents of societal expectations, organizational values, norms and beliefs, society’s evaluation and reconnection, can each be used as a lens to examine the crisis and understand its impact on American society (Svesson and Wood, p. 303). The 2008 financial crisis arose as a result of many factors, but the central causes of the crisis revealed legal but unethical business practices caused a domino effect as the economy collapsed. By examining the rise of consumer culture in the 1990s, unethical banking industry practices, and the government’s response, one can see how American individual values were in conflict with American corporate values.
The United States economy in the 1990s and early 2000s was ripe for a financial crisis. Economic prosperity engendered government deregulation, the introduction and augmentation of subprime mortgages, and increasingly unethical but legal practices in the banking industry. In 1933, the Glass –Stiegel Act was passed, which regulated interest rates, established deposit insurance, and erected a wall between commercial and investment banking by restricting the former from engaging in nonbanking activities like securities and insurance. In 1978, the massive promotion of credit cards by banks led to the dramatic growth of credit card debt (Collins). Throughout the 1980s,investors pursued alternatives including the money market, venture capitalism and hedge funds, because they were loosely regulated instead of conventional interest bearing accounts (Collins). In 1982, Congress passed the Garn-St. Germaine Depository Institution Act, which deregulated the savings and loan industry (Collins). This deregulation contributed overspeculation and led to a crisis which would cost the taxpayers $201 billion. The deregulation of interest rates at conventional banks also led to elimination of bank net-worth, accounting standards, and loan-to-value ratio requirements. The financial crisis in part stemmed from President Clinton’s efforts to make housing more affordable for a greater number of people.In his second term as president in 1995, Bill Clinton announced his National Homeownership Strategy (McLean and Nocera 32). It had the explicit goal of raising the number of homeowners by eight million families over the next six years. The policy was to get millions more American families into homes to make it possible for poorer people to buy homes, which was inevitably going to mean charging higher fees and interest rates (McLean and Nocera 32). Clinton announced this issue by saying,“We have a serious, serious unmet obligation to try to reverse these trends,” referring to the drop in the homeownership rate (Clinton). To achieve this, the administration advocated “financing strategies fueled by creativity to help homebuyers who lacked the cash to buy a home or the income to make the down payments” (McLean and Nocera 32). These efforts provided loans to unqualified buyers causing unintended consequences in the economy. Republican Phil Gramm successfully led the effort that repealed most of the Glass-Stiegel Act, a depression era law that kept commercial banking and investment separated (Collins). In the early 2000s, investors in the United States and abroad, who were looking for a low-risk and high return investments, started investing their money in the United States housing market. They saw better returns from the interest rates homeowners paid on mortgages (Polk and Polk). As investors strayed from investing in instruments such as United States treasury bonds which were paying very low interest rates, the focus turned to the housing market.
Time-line
■1933 the Glass –Stiegel Act–Regulated interest rates, established deposit insurance, and erected a wall between commercial and investment banking by restricting the former from engaging in nonbanking activities like securities and insurance.
■1978–The massive promotion of credit cards by banks led to the dramatic growth of credit card debt
■1980s–Investors pursued alternatives including the money market, venture capitalism and hedge funds, because they were loosely regulated instead of conventional interest bearing accounts
■1982 the Garn-St. Germaine Depository InstitutionAct –Deregulated the savings and loan industry
One of the factors fueling the surge in the housing market was the proliferation of subprime mortgages, or mortgages given to individuals with a poor credit history that were at risk with a higher likelihood to fail to repay, or default on their mortgages. Clinton’s housing initiative was designed to place low-income families into homes, but these families often had extraneous risk factors that resulted in a low credit rating, making them more vulnerable to unethical banking practices such as the adjustable rate mortgage. This type of loan starts with a low rate that increases at certain agreed upon points during the term of the loan (McLean and Nocera 32). This type of loan would be affordable to the buyer at the beginning of the loan, but could become unaffordable as time passed. In the mid-1990s, the subprime market was exploding. In 1994, the Federal Reserve began to increase rates, and refinancing plummeted. This left “prime” lenders, whose loan volume dropped by as much as 50%, looking for a new source of loans (McLean and Nocera 35). Not only did their loan volume drop, but also their fee income plummeted. Traditionally, it would be difficult, if not impossible, to get a mortgage from a bank if one had insufficient or marginal credit or if one was unemployed. Banks most likely would not want to take the risk of a default on a loan, but all that started to change in the 2000s (Polk and Polk).
These banks knowingly wrecked the lives of individuals in return for a short term profit. The ethics and morals were deplorable at the time.The banking industry profited from the surge of questionable mortgages by creating specific types of investments that collated these assets into an attractive, high-yield opportunity for investors of all types. Fannie Mae and Freddie Mac, government-sponsored enterprises and publicly traded companies, guaranteed mortgages with lower down payments, but they had higher return values. This pushed their their profits to over $1 billion. Maxwell retired in 1992 as Congress passed a bill imposing on Fannie Mae and Freddie Mac to help with the Housing Initiative (McLean and Nocera 46). The pressure on Fannie Mae and Freddie Mac from the Office of Federal Housing Enterprise Oversight led to big banks giving out risky loans to home buyers. This included banks providing loans to those individuals that would never repay the loans. These banks knowingly wrecked the lives of individuals in return for a short term profit. The ethics and morals were deplorable at the time.
“IN THE EARLY 2000S, INVESTORS IN THE UNITED STATES AND ABROAD, WHO WERE LOOKING FOR A LOW-RISK AND HIGH RETURN INVESTMENTS, STARTED INVESTING THEIR MONEY IN THE UNITED STATES HOUSING MARKET. THEY SAW BETTER RETURNS FROM THE INTEREST RATES HOMEOWNERS PAID ON MORTGAGES” — Mclean
The banking industry profited from the surge of questionable mortgages by creating specific types of investments that collated these assets into an attractive, high-yield opportunity for investors of all types. Buying up single mortgages was” too much of a hassle”, so investors instead sought investments called mortgage-backed securities (Polk and Polk). Mortgage backed securities were comprised of loans that were pooled together and sold to investors (Polk and Polk). Investors bought up these mortgage-backed securities because they were thought to be safe, quality investments with reasonable return rates. Worst-case scenario the loan would default on the mortgage and the banks could just sell the house for more money (Polk and Polk). At the same time, credit ratings agencies told investors these mortgage-backed securities were safe investments. A great deal of these mortgage-backed securities were given “AAA” ratings, which represents the highest quality loans. People thought mortgages were only for borrowers with good credit. Fannie Mae appealed to investors because of the government backing. The perception was that these loans were “[s]afer than triple-A-rated bonds because of the ‘implied government backing of Fannie Mae’” (McLean and Nocera 45). In reality, loans of all qualities from “AAA” to “junk”, had been packaged and sold for years. The difference this time is that bad loans were now packaged and sold as if they were quality loans. Once the loans started to default, a domino effect ensued as the homes that secured many of the loans individual borrowers had purchased were not worth the value of the loan, causing a cascading reaction in the banking industry as less capital was available for other types of loans. This result was due to the unethical practices of the big banks.
Brokers throughout the period of the rise of consumer credit culture became increasingly unethical in their practice. Their practices directly violated the business ethics model created by Svensson and Wood but were still legal.The brokers who sold the loans to a third party would often not check for proper credit or income of whomever was seeking a mortgage loan (McLean and Nocera 165). They would sell these high-risk bonds as “AAA” bonds in order to make a profit. This was likely to be fraudulent as it was blatantly lying to the buyer (Polk and Polk). This would be an example of asymmetric information, in which the brokers were aware that these bonds were risky to the buyers and took advantage of that, resulting in drastic effects on the economy.In 2006, the market began to collapse with a subsequent rise in interest rates while monthly mortgage payments on subprimes began to increase as these were adjustable rates, and many homeowners were no longer able to afford them. They began to default and investors who bought these toxic mortgages realized that they would not be able to pay their debts. As investors discerned that their “safe” investments were actually highly unstable, their confidence disappeared (Kline). The credit market contracted abruptly as banks were foreclosing on properties that were not worth their loan value. Brokers pursued these unethical practices knowing they would be able to make a profit, leading to huge problems in the economy.
“GOLDMAN HAD BECOMING INCREASINGLY RUTHLESS, INCREASINGLY CUTTHROAT, AND INCREASINGLY CONCERNED ABOUT ITS OWN BOTTOM LINE–AND ITS BONUSES. ‘THEY’D CUT YOUR EAR OFF FOR A NICKEL, RIP YOUR THROAT OUT FOR A QUARTER, SELL THEIR GRANDMOTHER FOR A PENNY, AND SELL TWO GRANDMOTHERS FOR TWO PENNIES!’ — groused one private equity executive’” (McLean and Nocera153).
Leading financial firms like Goldman Sachs made enormous profits, encouraging brokers to disregard the mortgage holder and instead focus on selling the maximum amount of loans in the various products knowing that these products were not beneficial for either the consumer or the investor.In the early 2000s, Goldman Sachs had adjusted to business as a public company and went on a run to a degree rarely seen in corporate America. Its revenues rose from $16 billion in 2003 to nearly $38 billion in 2006; its market cap that year topped $88 billion (McLean and Nocera 153). “Goldman had becoming increasingly ruthless, increasingly cutthroat, and increasingly concerned about its own bottom line–and its bonuses. ‘They’d cut your ear off for a nickel, rip your throat out for a quarter, sell their grandmother for a penny, and sell two grandmothers for two pennies!’ groused one private equity executive’” (McLean and Nocera 153). The operating principles of the big banks was a cesspool of greed, including unethical practices with criminal intent, giving a terrible name to free market capitalism. As the banks saw the housing bubble starting to deteriorate, they began to refuse to lend money. Small businesses became unable to secure loans, decreasing production, which subsequently led to their closing while rapidly increasing the unemployment rate. Losing their jobs and their houses, American families went deeper into debt (Messah-Ericksen).During the housing bubble, Wall Street was considered the heart and soul of free market capitalism, but when they were in danger of total collapse they changed their free market ways to socialist ones begging the government and taxpayers to bail them out.
The economic collapse and urgency surrounding the repercussions of the banking industry’s choices and subsequent fallout gripped the nation, but both the population and the government were appalled at the industry’s request for large amounts of funds. The big banks were “too big to fail” and allowing them to fail could have created a worldwide depression. Consequently,Secretary of Treasury, Henry Paulson, gave a $700 billion “bailout plan” on September 19, 2008. The government was to purchase toxic mortgage loans from troubled financial firms specifically loans that people had defaulted on and were still bank assets,. After an initial rejection, Congress passed the bill, and it was signed by President Bush. On October 14, 2008, the Treasury Department unveiled a plan to spread $250 billion on new preferred stocks of the nine largest banks as well as larger regional banks; in exchange the banks would be required to extend loans to smaller banks and limit executive compensation (Messah-Ericksen). The majority of the money fromTroubled Asset Relief Program, better known as TARP, was repaid to the government with interest. However,CEOs who helped to create these problems still received significant compensation (McLean and Nocera 165). They were not penalized in and were actually rewarded, which led many to question whether CEO payment methods were fair or needed alterations. Bank executive pay came under significant scrutiny and rightfully so. These bank executives who had lead and promoted unscrupulous and predatory lending practices were not held accountable for their actions. The ratings agencies also were pardoned for their actions. They betrayed the public trust and investors lost billions of dollars and in some cases were ruined. The government bailout allowed the banks to get away with their unethical practices without repercussions.
The Special Inspector General for TARP’ssummary of the bailout of 2011 stated that the total commitment of government was $16.8 trillion dollars with the $4.6 trillion already paid out (Collins). The government’s original plan that was published to the public did not accurately describe the true plan of the bailout. The ongoing bailout was kept secret because Chairman Ben Bernanke, argued that revealing borrower details would create a “stigma”. Bernanke argued that investors and counterparties would “shun” firms that used the central bank as lender of lastresort (Collins). Seven point seven trillion of the secret emergency lending was only disclosed to the public after Congress forced a one-time audit of the Federal Reserve in November of 2011. This audit revealed that there were no requirements attached to the bailout money and banks were able to use it for any purpose. The big banks involved in unethical and even criminal behaviour received little to no punishment for their actions.
SUMMARY OF THE BAILOUT OF 2011 STATED THAT THE TOTAL COMMITMENT OF GOVERNMENT WAS $16.8 TRILLION DOLLARS WITH THE $4.6 TRILLION ALREADY PAID OUT. THE GOVERNMENT’S ORIGINAL PLAN THAT WAS PUBLISHED TO THE PUBLIC DID NOT ACCURATELY DESCRIBE THE TRUE PLAN OF THE BAILOUT. THE ONGOING BAILOUT WAS KEPT SECRET BECAUSE CHAIRMAN BEN BERNANKE, ARGUED THAT REVEALING BORROWER DETAILS WOULD CREATE A “STIGMA”.
It was proven that the American Division of the HSBC bank engaged in money laundering for Mexican drug cartels to the tune of $881 billion; this was yet another situation of unethical banking practice. (U.S. Department of Justice: Criminal Division). The penalty to this bank for blatant corruption was $1.9 billion and the New York Times laments that HSBC was too big to indict (U.S. Department of Justice: Criminal Division). Both JP Morgan Chase and Goldman Sachs worked with hedge funds to bet against the toxic mortgages after the crash had started. They made money by selling short on the financial catastrophe that they had created (Messah-Ericksen). JP Morgan was fined $296.9 million and Goldman Sachs was fined $550 million for actions; these fines were a mere fraction of their total profit. Again, no executive ever went to jail for these unethical and complicit actions because they did not technically break any law (Collins). The cost to taxpayers was extremely high and the actual cost versus benefits of the bailout will be difficult to determine for a long time.
“It was all a lie — one of the biggest and most elaborate falsehoods ever sold to the American people. We were told that the taxpayer was stepping in — only temporarily, mind you — to prop up the economy and save the world from financial catastrophe. What we actually ended up doing was the exact opposite: committing American taxpayers to permanent, blind support of an ungovernable, unregulatable, hyperconcentrated new financial system that exacerbates the greed and inequality that caused the crash, and forces Wall Street banks like Goldman Sachs and Citigroup to increase risk rather than reduce it” — Taibbi
During the bailout, with free use of the bailout money, the government allowed many of the banks to use taxpayer bailout money to merge: Chase and Bear Stearns, Wells Fargo and Wachovia, Bank of America with Merrill Lynch (Collins). Today, the big banks have become even bigger turning into an oligopoly that controls a huge amount of money. The 12 largest banks in the country now control 70% of all bank assets (Collins).
From The Federal Reserve board in Dallas in 2010, Senator Sherrod Brown submitted a bill to break up the big banks. His bill failed with a mere thirty three votes in the senate. If the public would have known of the secret bailout using trillions of taxpayer dollars, the bill might have passed (Taibbi). By breaking up the monopolies, the risk would be substantially lowered for a repeat of unethical practices that led to collapse of the economy. From Taibbi’s model on how to avoid a future economic crash, he suggests that a modified version of the Glass-Stiegel Act should be put in place that separates the commercial part of the banks from the investment part as well as additional regulations. The FDIC insurance should apply and protect only commercial bank operations not the gambling part of the banks (Collins and Taibbi). The model further discusses the elimination of rating agencies, such as Moody’s and Standard & Poors, should be eliminated because they are paid by the banks, creating a conflict of interest. Taibbi adds that the hedge fund tax should be raised from fifteen percent to thirty-five percent because they profit from insider tips, high frequency trading, rumor mongering, front-running trades, special tax loopholes–even from stocks that are failing. Taibbi believes that these and many other of the practices surrounding hedge funds are unethical. Lastly, he feels that CEOs and other top-ranking managers should be held legally accountable for their actions. Without consequences from their decisions that are technically legal, but unethical, there should be laws put into place to regulate their actions in order to use “fear” as a discourager from participating in unethical actions (Collins). William Banzai, a critic of the big bank corporations from the crash, said that “If we don’t get rid of the incentive to loot, then the only question is what form the next round of looting will take.” (Collins). Taibbi ends his report stating, “The choice is clear, either we regulate the big banks like we did during the New Deal or they will eventually destroy both themselves and the economy” (Taibbi).
Wall Street contributed to eight million people losing their jobs and the greatest recession since the Great Depression. The unscrupulous and predatory lending practices of the banks led to the emergence and explosion of the subprime mortgage crisis. The United States and global economies were on the brink of collapse before the bailout. While history has questioned the picking of “winners” and “losers,” the economy was ultimately saved at the expense of “Main Street.” More specifically, millions of people lost their homes and investors had their life savings destroyed to support the big banks or Wall Street. Along the way, no bank executive or member of any ratings agency ever went to jail for the fraudulent and predatory practices. The government created the problem by promoting loose credit to marginal or unqualified buyers, and they ultimately had to fix the problem. Congress blamed everyone involved but themselves and failed to take responsibility. Legislation has since been created to prevent brokers and banks from taking advantage of and defrauding individuals, especially those who are considered at risk and to provide more regulatory restrictions on the banks. This act is known as the Dodd-Frank Act In order to avoid something like this in the future, there has to be more regulation and consequences to those who put the world economy in danger for their own personal gain.
Know this:
■Wall Street contributed to eight million people losing their jobs and the greatest recession since the Great Depression ––The unscrupulous and predatory lending practices of the banks led to the emergence and explosion of the subprime mortgage crisis
■ The United States and global economies were on the brink of collapse before the bailout –– Millions of people lost their homes and investors had their life savings destroyed to support the big banks or Wall Street
■NOT ONE bank executive or member of any ratings agency ever went to jail for the fraudulent and predatory practices
■The government created the problem by promoting loose credit to marginal or unqualified buyers, and they ultimately had to fix the problem
■Congress blamed everyone involved but themselves and failed to take responsibility –– The Dodd-Frank Act- created to prevent brokers and banks from taking advantage of and defrauding individuals and to provide more regulatory restrictions on the banks
Works Cited
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