Countrywide Financial and the Subprime Mortgage Crisis

Introduction

In 2006, the world discovered that Countrywide Financial and other lenders had been promoting mortgage practices that were not merely impractical — they were criminal. Countrywide was one of a number of corporations, but the one with the largest number of questionable mortgages, which followed a then-recent push by the government to incentivize companies to offer home loans to a greater number of people. These types of loans are called subprime because the borrowers do not qualify under normal lending standards. Because of this government push, which became an internal 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 adjustable-rate mortgages (ARMs).

An ARM is a mortgage in which the interest rate can change over a specified period — typically once a year — to reflect the prevailing average loan rate. An ARM usually lasts for a five-year period, after which the lender can require the borrower to obtain a new loan, continue under the same terms, or make a balloon payment. Because of this structure, many borrowers were unable to meet their obligations and ultimately defaulted, leaving Countrywide unable to recover its capital. Compounding the problem, many securities had been backed by these loans. When borrowers began defaulting on their mortgages, those securities also declined sharply in value, causing serious trouble for banks that had tied up a significant portion of their assets in such instruments.

This paper examines what happened during the crisis, the steps and missteps that Countrywide made, and what ultimately became of the company.

Problem Statement: Countrywide Financial abandoned its ethical standards when it encouraged company-wide fraud and concealed the bulk of its actions from Securities and Exchange Commission auditors and its own internal fraud monitors.

Business Model and Market Conditions

Assessment: Countrywide was already one of the largest mortgage lenders in the world when the pressure to expand into subprime lending intensified. The government regulations requiring that more people in lower-income brackets be given access to home purchases had understandable moral appeal, but they did not make sound business sense. Inexplicably, lenders did not believe — until the very end — that a market bubble would catch up with them. The perspective of Countrywide and other lenders was distorted by the enormous profits being generated, and this mixture of oversight failure and active fraud ultimately produced the mortgage debacle.

The original business model was probably sound, but as the company's ethical standards eroded, so did the stability of the model itself. What emerged was a framework of ethical relativism: because everyone else was engaged in the same practices and the government appeared to endorse them, Countrywide executives used this rationalization to pursue greater profits for themselves and their shareholders.

Almost every major player in the market was doing the same as Countrywide. The key distinction was that Countrywide had more to lose because it held a larger proportion of suspect mortgages than any other private lender — with the possible exception of Fannie Mae and Freddie Mac, which were government-backed entities. Because so many banks were engaged in similar practices, the market for these types of loans remained robust and appeared sustainable for a time.

Countrywide was one of the largest mortgage lenders in the United States, and its willingness to actively engage in fraud allowed it to acquire more subprime mortgages than any competitor. The primary organizational goal was profit, and this greed blinded management to the underlying risk. The more mortgages the company held, the more cash flow it generated — until borrowers began defaulting en masse.

Competitive Strategy and SWOT Analysis

The largest area of concern was the open facilitation of fraud and the suppression of internal dissent. Employees who raised concerns and escalated them to management were silenced through demotion or termination. A second critical issue was the company's relativistic ethical structure: rather than adhering to the mission and values that had built its reputation, management during this period focused on what competitors were doing and followed suit, abandoning the principles that had originally made the company successful.

The competitive strategy was to absorb more loans than any competitor. A company can gain market share by offering customers more of what they want than rivals are willing to provide. During this period, Countrywide was willing to go to any lengths to place people — qualified or not — into homes. Consumers understood that if they wanted a mortgage product, they were more likely to obtain it from Countrywide than from anyone else. This strategy succeeded in increasing the volume of loans Countrywide carried, reinforcing its position as a market leader. Additionally, the company generated further revenue by investing in securities that contained these loan packages.

The greatest strength Countrywide possessed was its long-standing market presence and strong reputation. Its nationwide network also allowed the company to acquire subprime mortgages at a far higher rate than most of its competitors could manage.

Countrywide's primary weakness was its scale: the company was too large and had committed too much capital to what ultimately proved to be non-performing loans.

In principle, Countrywide had a significant opportunity to become a more responsible lender by learning from its mistakes. In practice, however, the company was absorbed by Bank of America following the onset of the crisis, and that opportunity transferred to the acquiring institution.

Conclusion

Countrywide and other lenders saw an opportunity brought on by large amounts of available capital, legislation that encouraged subprime lending, more than a decade of rising home equity, and consumers who — while perhaps not ideal credit risks — genuinely wanted to purchase homes. The problem is that Countrywide responded to this environment with greed rather than disciplined financial judgment. The result was an ethical framework grounded in relativism, which ultimately led to the company's downfall. It is a costly and painful lesson that sound ethical business practices preserve value and prevent institutional catastrophe in the long run.