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Describe about the Following Laws versus Rules for Interpret Ethical Issues with Subprime Loans?
Interpret Ethical Issues with Subprime Loans
Summary of the concept of subprime loans and the risk of subprime loans to the lenders and borrowers:-
The subprime loan is a type of very low or no down payment loan which has an option of second loans that act as the down payment for the first loan and eliminate the necessity of cash down payment of monthly premium for PMI (Private Mortgage Insurance).The households or peoples with less than moderate incomes, having imperfect credit records and very limited wealth to access the housing loans to refinance the existing home or buy a new one are the greatly benefitted from this Private Mortgage Insurance or PMI Scheme(OCC, 1999). This type of loan results in a boom in the housing sector as this includes the opportunity to access easily the loans, which leads to a decrease in the interest rate and a rise in the income. According to the marketing data, there was a spread of this housing bubble outside the housing sector, which caused a slowdown in the economic progress. The economy is still suffering from this recession due to the high unemployment rate and weak economic recovery (Utt, 2008).
Having a poor past credit history, serious credit problem, income of the state, high doubt to income ratio, the subprime loan borrowers are considered as a person and it is not possible for him to documented all the underwriting information in the applications and always go for the high LTV or, loan to value mortgage. Because of the high-interest rate, there is a risk to the borrowers for defaulting during the ongoing situation. Foreclosure on their home is considered as the second risk. It was found that the price of the house owned by an individual or a borrower is lower than the down payments of his/her borrowings. Therefore, they keep the distance from that houses, which they cannot purchased and let the lender foreclosures on the assets. Having the higher delinquency rates compared to the standard prime mortgage is considered as having risks of sub-prime loans to the lenders (OCC bulletin 99-10 (1999), 1999). The lenders also have the higher loss rate risks besides, the higher delinquency rates. As the lenders cannot manage the loss, they may leave the business because of the combined effects of high delinquency rates and loss rates (Ethical Issues with Subprime Loans, 2014).
The role of leadership decision-making in the subprime loan during the financial crisis:-
On subprime loans, the majority of the home mortgage loan defaults is dependent with a high-interest rate loan to the buyers of home and this type of risk is higher than the average credit risk. To extend the number of home ownership for the Americans, the federal government had encouraged the bank to make sub-prime loans. The banks are the biggest indirect investors in the subprime loans. The money that had been lent by the banks from the investment companies is used to purchase a large number of Mortgages from the mortgage lenders (Turano, 2006). It becomes difficult for many investment funds to repay the loans that he had taken out from the banks. Hence, a declaration about the uncoverable loans should be made by the banks. However, this process will lead to a declining in reserves and generate the new loans. As both the businesses and consumers depend on the loans to finance the investment expenditures, the introduction of subprime loans will threaten the economy.
Because of this poorly structured subprime-lending program, there are major losses and other problematic issues faced by most of the institutions of U.S.A. The higher default race and the loss-on default rates involving with the subprime lending and high overhead costs are underestimated by the institutions which frequently lacked the business planning process, management expertise and risk management processes which are very necessary to eliminate the risks associated with the subprime loans in a safe and sound manner. Hence, in financial institutions, leadership play a very critical role, as their decision-making will affect the other institutions or other individuals. A leader of the financial institution must have the quality of integrity, accountability and the responsibility (Thiel, 2012). If a leader ignores these duties, then there will arise a big problem for the institution. This similar case happened in the case of the sub-prime loan. Despite the ethics in leadership is to focus on moving forward, the financial and corporate misconduct amidst in the subprime lending that have left few wonderings (`The Ethical Challenges of Subprime Loans`, 2015).
With the notion of social responsibility evaluating the effect of subprime loans:-
In 1995, the total subprime loans were only $18.5 billion whereas after ten years in 2005 it was increased to 507.9 billion. Hence, between the decades of 1995-2005 the economy faced a huge increase of subprime loans i.e. 489.4 billion U.S. dollar. However, there was a burst of the housing bubble in the housing market since the year 2005, which resulted in an increase in the interest rate. Hence, there were foreclosures of purchased houses through the rising sub-prime loans, which indicated that there would be the continuous rise in foreclosure. This led to damage in the housing market, which has a spill over affect the overall economy and results in recession in the economy (Bryson, Bryson, Bryson, Bryson & profile, 2015).
To promote the home ownership, there are some goals of American policies. The U.S. government has set up different financial institutions to make the purchasing process of home easier, quick and also convenient to provide the home to every citizen. This is a kind of social responsibility of U.S. government on the low-income group families and the minority group of the society. To protect this social responsibility, in 1938, the Federal Nation Mortgage Association, FNMA, or Fannie Mae was set up by the U.S. government with the primary goal to provide a secondary market for home mortgages. That is if there is a need for funds after granting the mortgage to the borrowers, the mortgage can be easily sold by the banks to the borrowers and later if there will a need for funds for the banks, the mortgage can be easily sold to the FNMA by the banks. The lending institutions that have the access to the secondary mortgage market of FNMA had to abide by the rules of FNMA. The U.S. government focused on creating another institution to compete with FNMA in the secondary mortgage market, after its privatisation. The Federal Home Loan Mortgage Corporation or FHLMC or Freddie Mae was created by U.S. government in 1970 to expand the secondary mortgage market (Hagerty, 2008). The consumers or the borrowers cannot get direct loans from both the institutions FNMA and FHLMC. The main aim of these two institutions is to increase the number of low-income families and the number of a minority to own their home (Myassignmenthelp.com, 2015).
Since the time to assure that this will not happen again, what measure should be taken?
During the period of 2007-2008, when the U.S. economy faced a financial crisis, an overall measure was taken by the government to tackle the problem, as it was known to the problem that what was the problem and how to prevent it that it will not happen again. In the year 2007, there was a threat for the mortgage lenders as well as for the all financial institutions due to the highest defaults on the home mortgage loan.
Several steps was taken by the government to provide the limited relief to eliminate foreclosures regarding the problems of sub-prime loans and to adjust and refinance the payments to stay current on their payments and to keep their homes the government will allow those steps with great credit opportunities. To strengthen the lending rules to prevent loans to being issued by people who are unable to pay the monthly payments and to offset the incentives generated by the mortgage-backed securities. To help the homeowners who are not able to repay some mortgage loans different legislations have been passed by U.S. government. In 2010, U.S. Congress has passed and signed the Wall Street Reform and Consumer Protection Act to send a new message to the executives of large financial corporation, the bondholders and the stake holders that if they allow their corporation again into the serious financial trouble, they will suffer from the extremely high and unavoidable financial losses (Board of Governors, 2012).
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Ethical Issues with Subprime Loans,. (2014). Ethical Issues with Subprime Loans. Retrieved 2 August 2015, from https://savdrew.wordpress.com/
Hagerty, J.R., H. (2008). Hagerty, J.R. (2008). Fannie, Freddie Mae shares suffer hit as mortgage default fear mount. The Wall Street Journal, March 11, 2008.
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OCC bulletin 99-10 (1999), O. (1999). OCC bulletin 99-10 (1999). Interagency Guidance on Subprime Lending.
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Turano, E. (2006), T. (2006). Turano, E. (2006). Subprime mortgage lending: recognizing its potential and managing its risks. Housing Finance International, September 2006.
US Board of Governors, U. (2012). Board of Governors. 2012. “The U.S. Housing Market: Current Conditions and Policy Considerations” Whitepaper, January 4.
Utt, R. D. (2008), U. (2008). Utt, R. D. (2008) The subprime mortgage market collapse: A primer on the caused and possible solutions. The Heritage Foundation Leadership for America, April 22, 2008. Retrieved from https://www.heritage.org/research/report/2008/04/the subprime mortgage market.