Countrywide Financial Corporation and the Subprime Mortgage Debacle
In 2006, the world discovered that Countrywide Financial and other lenders had been promoting mortgages practices that were not impractical, they were criminal. Countrywide was one of a number of corporations (but the one with the largest number of questionable mortgages) which followed the lead of a then recent push by the government to provide incentives to companies that offered a greater number of people home loans. These types of loans are called subprime because the people who want the loan do not qualify under the normal rules. Because of the government push, which became a push within the company, countrywide offered a greater number of loans to people who could not afford them, and many of these were structured as ARMs. An ARM is an adjustable rate mortgage one in which the rate can change over a specified number of years, once a year, to reflect the new average loan rate. An ARM usually last for a five-year period after which the lender can require the individual to get a new loan, continue in the same agreement, or make them pay a balloon payment. Because of this, many people had to default in these loans and Countrywide could not get its money back. To make matters worse, some securities were backed by these loans, and when the people started to default on their mortgages, these securities also took a dive. This caused many banks serious trouble because they had a great amount of their assets tied up in these securities. This paper looks at what happened during the crisis, the steps and missteps that Countrywide made and what became of the company.
Countrywide Financial lost their ethical stance when they encouraged companywide fraud and kept the bulk of their actions from securities and exchange commission auditors and their own company fraud monitors.
Countrywide was already one of the largest mortgage lenders in the world when the push came to make more of these types of investments. The reason that the government had passed the regulations which demanded that more people in lower income brackets be able to purchase homes was a good thought morally (it seemed), but it did not make business sense. For some reason, the bankers did not believe, up until the very end, that they would be caught by any type of bubble. The perspective of Countrywide and other lenders was tainted by the amount of money that they were making. This oversight and active fraud led to the mortgage debacle.
The original business model was probably good, but as the companies ethics faltered, so did the stability of the business model. The model became one of ethical relativism. Everyone else was doing it, the government endorsed the practice, so Countrywide executives used these new fraudulent ethics to make more money for themselves and their shareholders.
Almost everyone else in the market was doing the same as Countrywide; it is just that Countrywide had more to lose because they held more suspect mortgages than anyone else (with the possible exception of Fannie and Freddie, but they were government backed mortgage houses so they do not count). Many banks were in on the practice so the market for these types of loans was good.
Countrywide was one of the largest lenders in the United States. In the end, they held more (basically) unsecured mortgages than any other company. Because they were so large and held so many subprime mortgages they did enjoy a competitive advantage. The fact that the company was willing to actively engage in fraud helped them to acquire more of these types of mortgages than anyone else.
Goals and Ambitions
The primary goal of the company was to make money. This greed so blinded the managers of the firm that they were willing to take on more of the subprime mortgages because the more mortgages they owned, the more money was being paid back to them. The problem came when many of these people stopped paying.
Areas of Concern
The largest area of concern was the open fraud, and the fact that employees who were willing to blow the whistle and did, in fact, talk to higher ups were silenced by demotion of termination. Another issue is the relativistic ethical structure. Instead of sticking to the mission and values that made the company what it was, the managers during this period focused on what the market was doing and did what everyone else did.
The competitive strategy was to absorb more loans than anyone else did. A company can gain market share by giving the customer more of what they want than the next company is willing to. During this period, Countrywide was willing to go to any lengths to get people, qualified or not, into a home. This meant that consumers knew that if they wanted a mortgage product, they were better able to get one from Countrywide than anyone else. So, the strategy worked to increase the amount of loans that Countrywide was carrying, and they became an even greater market leader. Also, Countrywide could make more money by investing insecurities that contained these types of loans.
The greatest strength that the company had was its long standing in the market and the good reputation that they had. Also, because of its nationwide network, Countrywide was able to acquire subprime mortgages at a greater rate than many of its competitors.
Countrywide was weak in that it was too large, and had too much money invested in what turned out to be bad loans.
Now the company has great opportunity to become a better lender because it is possible to learn from the mistakes of the past. Unfortunately, Countrywide was absorbed by Bank of America which was financially responsible, and the opportunity reverts to that lender.
The threat was that the fraud that Countrywide was perpetrating would be found out (it was), and that the loans that they offered would cause them to collapse under the weight of bad mortgages (which they did).
A situational analysis is a combination of a SWOT analysis and other tools such as a Porter's Fie Forces analysis. The researcher or manager uses this data to determine what the internal and external environments of an organization. In the case of Countrywide, externally (a PEST analysis is a good tool here) the company was encouraged to offer the types of mortgages that it did. The governments new rules dictated offering more subprime loans, and socially the company was also pushed to provide loans to more people. Economically, it did not seem like the increase in housing values (later called the "housing bubble") would ever decrease, and the technology was available to predict that the loans were sound because the investors were earning so much money in equity.
Internally, the company was financially sound at this time, and they had a group of lending associates who were willing to do what it took to pass the loans. The company encouraged this activity also. This made for an atmosphere in which unethical practices and fraud were encouraged.
Porter's Competitive Factor
The threat of new competition was not great because Countrywide had such a wide network that it would be difficult for new competitors to match them. There was a threat of substitute products because any lender could come up with a new loophole to exploit. The customers did not have leverage because they would not normally have been able to secure the loans and there was no supplier issue because Countrywide was the supplier. The greatest competitive threat was the fact that other lenders were just as anxious to make the loans as Countrywide was. There was a lot of competitive intensity in the business at that time.
Situation Analysis (financial part)
Net Profit Margin in the fourth quarter of 2006, before the crisis, was 4.05 (based on a $2.59 billion profit and $638.9 million in sales) to a post crisis rate zero. P/E ratio went from a high of approximately 10 in 2006 (earnings $4.42, stock price $42.45) to zero in 2007 (loss -$2.03, stock price $8.94). The company had posted earnings greater than $2 billion for the four years prior to the crisis (2003 through 2006) and a loss of $703.5 million the year after. Basically, the company lost $3 billion dollars from its prior earnings record from 2006 to 2007. These figures show the devastation caused by the poor judgment of Countrywide and how quickly those bad loans reversed their fortunes.
The alternative to the practices that were rampant in the company at the time was that they could have followed an ethic of social responsibility. The gathering of a large amount of bad loans may have been couched in the idea of social responsibility, but it was actually antithetical to that idea. The greatest alternative to their actions was…