Ethical and legal issues in subprime mortgage lending

Sub-Prime Mortgage Lenders

Ethical Legal Issues

Ethical and legal issues concerning sub-prime mortgage lenders

The essay is aimed at exploring the subprime mortgage lending and related ethical and legal issues.

Subprime mortgage has become an influential industry in particular due to the increase in trend to take loans for house purchase in an average American.

Ethical Issues involved

Legal Issues

Ethical and legal issues concerning sub-prime mortgage lenders

Subprime Mortgage Industry

Legal Issues

Ethical Issues

CONCLUSION AND SOLVING THE PROBLEM

Ethical and legal issues concerning sub-prime mortgage lenders

A mortgage loan is the single chance for purchasing a home for an average American and so the subprime mortgage has become a prominent industry. With the emergence and growth of the industry is facing many legal and ethical issues. The current essay is a discussion of these issues.

During the last decade there was an extraordinary boost in mortgage originations, in particular the subprime mortgage market widely spread. The subprime lenders provide loans to the people with weak credit histories at higher rates. During the early period of 2007 the mortgage industry experienced an unexpected raise in delinquencies and, later, foreclosures, in particular in the subprime field. The consequent unrest in the housing market prompted broader financial commotion, which is associated to the most recent universal recession. The essay is aimed at exploring the subprime mortgage lending and related ethical and legal issues.

Subprime Mortgage Industry

Subprime refers to the term used for less than prime loan products available to consumers that do not meet high standards of credit worthiness. Creditworthiness refers to the borrower's ability to repay a loan. Most companies use a form of credit score card that takes into account the consumer's financial health which may entail their assets, borrowing and employment history. Also, many consumers carry a form of credit rating from nationally known and utilized companies like Equifax and Trans Union. If a consumer has a low credit score, or scores below the desired level for a particular lender, the consumer may be considered to be a high-risk borrower and may be either be denied for a prime loan (usually with market rate interest rates) and thus may need to turn to a subprime lender that will offer a similar loan product but with a much higher interest rate.

Most of the loan products that are available within the prime lending industry are also available within subprime lending; however, additional small loans are available within the subprime lending industry to meet the needs of the consumer group that typically does not have access to traditional loans or that may choose to not bank in traditional forms. Although products within the subprime lending industry are more expensive, as this form of lending is often referred to as 'high-cost lending', there is a definite demand for these products as lending within this industry continues to grow. In a Housing and Urban Development (HUD) report, the subprime lending industry increased from $20 billion in subprime loans to $150 billion from 1993 to 1998, which is over 700% growth in five years ("Unequal Burden"). Prior to 2004, in the United States, 10,000 payday loan companies produced between $8 billion and $14 billion dollars in loans within a year's time, and pawnshop agencies increased from 5,000 outlets to close to 14,000 within a little over 15 years (Temkin and Sawyer 5-6). What this indicates is the great need for consumer credit that is not available through the prime market and thus is produced through subprime financial services.

Ethical Issues

Financial economists have worried about problems of mortgage lending, such as moral hazard (MH) and adverse selection (AS), financial markets for decades. Recent events, like the subprime default crisis, seem to indicate that these problems are particularly pronounced in mortgage markets. At the same time, mortgage markets have a structure that poses new challenges for the both the theoretical and empirical literatures dealing with MH and AS. Moreover, mortgage markets are some of the largest financial markets in existence and are essential to the efficiency of the real economy. Thus, a deeper understanding of the specific manifestations and implications of MH and AS for mortgage markets is in order.

Mortgage underwriters face a dilemma: either to implement high underwriting standards and underwrite only high quality mortgages or relax underwriting standards in order to save on expenses. For example, an underwriter can collect as much information as possible about each mortgage applicant and fund only the most credit-worthy borrowers. Alternatively, an underwriter could collect no information at all and simply make loans to every mortgage applicant. Clearly, the second approach, while less costly in terms of underwriting expenses, will result in higher default risks for the underwritten mortgages. Moreover, mortgage underwriters typically wish to sell their loans in a secondary market rather than hold loans in their portfolio. Investors do not observe the underwriter's eort and consequently do not observe the quality of the mortgages they are buying (Ashcraft and Schuermann, 2009). The recent mortgage crisis has brought a lot of attention to the potential agency conflict arising from the separation of loan's originator and the bearer of the loan's default risk. Policy-makers and market observers have emphasized that the originators of loans and the underwriters of mortgage-backed securities might have lacked proper incentives to act in the best interests of investors, and as a consequence this possible misalignment of incentives might have importantly contributed to the mortgage default crisis. Ultimately, these concerns resulted in a number of policy proposals, beginning on June 2009 when the Obama Administration released its Financial Regulatory Reform" proposal which calls for loan originators or sponsors to retain a part of the credit risk of securitized assets However, beside a general notion that aligning incentives requires the participants in securitization process to hold an economic interest in the credit risk of securitized assets (or skin in the game"), little is known about how to design these provisions efficiently, especially fully recognizing the long-term duration of assets in question. Consequently, this question has been the subject of significant and ongoing discussions among the Administration, Congress, regulators and market participants

Payday lending is "hurting families," according to the Center for Public Policy Priorities and other industry opponents. More than 60% of what the government spends on public assistance programs for low-income families is gained from low-income families by fringe lenders. It is estimated that rent-to-own, pawnshops, check-cashers, and payday lenders generated about $78 billion in 2001 (this number is higher in recent years) while public assistance programs cost $125 billion (Karger 6).

Families are further getting into debt and payday lending is contributing to the number of families that end up filing for bankruptcy. In a study comparing payday lenders who were approved vs. denied by lenders in Texas, first-time borrowers were two-times more likely to file for bankruptcy within two years of the loan that those borrowers that were denied the first time (Skiba and Tobacman, Do Payday Loans Cause Bankruptcy 20). According to this study, payday loans do lead to bankruptcy because those that access payday loans are already financially strained individuals, they make repeated use of payday loans, and in the at the time of bankruptcy, these loan debts end up amounting to 11% of the liquid debt interest burden (Skiba and Tobacman, Do Payday Loans Cause Bankruptcy 1).

In addition to hurting families, namely those within minority populations and women head of households in their mid-30's, the elderly and other vulnerable populations, the military are also hurting in more ways than one. Not only are they part of the statistic of people that are paying high amounts in fees and finance charges, but they are also hurting at work. In the military, those that default on their loans run the risk of losing security clearances necessary to perform their duties, and as a report produced by the U.S. Department of Defense states, the high debt and stress related to payday loans posed a threat to morality of military personnel when performing security tasks ("Report on Predatory Lending Practices").

CONCLUSION AND SOLVING THE PROBLEM

The payday lending industry has had an ability to charge increasingly higher interest rates to vulnerable communities, while it continues to evolve and prosper. For years it has undermined the economic welfare of its consumer base, financially hurting families, yet claiming to offer a financial product that is filling a financial gap left unserved by traditional banking institutions.

For years industry opponents and critics have called on legislators to solve the problems posed by payday lenders on such vulnerable populations. Regulating the industry has been a challenge from the early 2000s when very little was known about the industry, to the current day that we now know more about its practices and its ability to prosper and operate outside state usury laws. Calls to action are constantly put out by consumer protection groups like the Center for Responsible Lending, Consumer Federation of America, and Center for Public Policy Priorities and Association of Community Organizations for Reform Now (ACORN) among others, asking the public to encourage their legislators to pass laws that will effectively help regulate the industry. Yet to date, the payday lending industry has continued to grow and proliferate.