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Evaluate Countrywide role in the subprime mortgage debacle



Evaluate Countrywide role in the subprime mortgage debacle

Explain the cause of the housing bubble and its burst in the mid-2000s.  To what extent is this problem the result of ethical failure?  Explain.

The housing bubble and its subsequent burst was caused by unprecedented lending by banks to homebuyers, subprime mortgages. The banks gave loans to borrowers without much scrutiny  and people who would not have accessed loans under normal banking conditions found themselves with access to loans to buy houses. The interest rates  were so low and as such were not dictated by market. When the interest rates increased thousands of people were not able to repay their mortgages, house prices plummeted  and many home owners lost their homes. The house bubble could be blamed to ethical failure from the part of banks. The banks gave out loans to many people who previously could not afford those loans. If the banks were strict and followed their laid down guidance in lending this would have been prevented but as always greed took over rational thinking.

  1. Evaluate Countrywide role in the subprime mortgage debacle. Was the company’s conduct unethical or illegal?

Countrywide played a significant role in subprime mortgage debacle because it was among  the big players in the industry. The company was involved in subprime mortgage lending to prospective home buyers. However, when the interest rates rose sharply it became difficult for home owners to pay loans leading to default in payment and many home owners losing their homes. The company’s conduct was both illegal and unethical since it was involved in predatory lending. The company lend to people who did not have full knowledge of the cost involved. If the borrowers knew the total cost of these loans they would have decline to take the loans.

  1. If we are to ensure that a crisis such as the subprime mortgage debacle does not occur again, what changes should occur in companies such as Countrywide?

They should be forced to tell their customers the total cost of the loan. They should also be required by the law not to hide any information which in vital for decision making by the borrower. These companies should also be regulated and an oversight body put in charge of them to counter-check their actions.

  1. Using this case as an example, who benefits and who gets hurt when a company engages in unethical or socially irresponsible behavior?

The customers and shareholders get hurt while the executives of the company benefit hugely when a company get engaged in unethical behavior. The customers usually do not get value for their money. They get misled by such companies which take advantage to rip them off. The shareholders suffer in that at the end these companies are fined and their share price reduce in value. Management usually benefit by giving themselves hefty packages for the “hard work”.Evaluate Countrywide role in the subprime mortgage debacle

  1. Was the US Federal Government’s 1932 intervention in the market for home ownership desirable? How did the creation of Fannie Mae in 1938, Ginnie Mae in 1968, and Freddie Mac in 1970 expand homeownership and shape lending practices at banks and other mortgage-lending firms?

The intervention in the market for home ownership was desirable because it reduced the rate of default and set down rules to be followed to reduce the number of loan defaulters. The creation of Fannie Mae in 1938, Ginnie Mae in 1968, and Freddie Mac in 1970 expanded homeownership by allowing more people to access mortgage loans. Through them, some low income and medium income earners are able to become home owners. Due to their efforts, the banks nowadays lend to people who are eligible and they believe cannot default on the loans.

  1. Why did the US Congress enact the Community Reinvestment Act, the Home Mortgage Disclosure Act, the Depository Institution Deregulation and Monetary Control Act, and the Housing and Community Development Act? Was the legislation effective in expanding homeownership? Did the government’s promotion of subprime mortgages and high loan-to-value (LTV) subprime mortgages create additional risks for lenders and the holders of mortgage-backed securities (MBSs) or collateralized debt obligations (CDOs)?

The Acts were enacted to protected the less fortunate in the society from being discriminated by banks and other lending institutions.  It was effective in increasing homeownership since more people who could not access mortgage were able to access and buy homes. Government’s promotion of subprime mortgages and LTV created additional risks for lenders and holders of mortgage-backed securities because it led to brokers being greedy and relaxed the requirements to give out loans such as limited credit histories for the borrowers. This eventually led to housing bubble due to high rate of default.Evaluate Countrywide role in the subprime mortgage debacle

  1. Did subprime mortgage loans contribute to the housing bubble? Why did the bubble burst? What were the consequences of the housing bust to borrowers, loan originators, and MBS and CDO holders? Did subprime mortgages contribute to the US financial crisis of 2008?

Subprime mortgage loans contributed to the housing bubble because they were offered under weak terms and most people defaulted on them. The bubble burst when the loan holders were unable to repay when the interest rate in the market increased. Many defaulted and the value of houses came down. The borrowers lost their homes, loan originators lost money and became bankrupt, MBS and  CDO holders also lost their money and assets since the value for their houses also went down and the lenders seized their assets.

  1. How did Federal legislation concerning mortgage loans affect Countrywide Financial Corporation’s (CFC) business strategy? Did the government’s encouragement of subprime mortgages have an impact on the company’s number of loan originations between 1990 and 2007?

Federal legislation promoted homeownership across the country. Companies like Countrywide came up with a business strategy designed to lend out money to the low income earners. However, such loans were very expensive but borrowers did not know

  1. What effect did the housing boom and the growth in origination of subprime mortgages have on CFC’s financial performance? Evaluate the financial rations presented in case Exhibit 8 and calculate compounded annual growth rates for items in CFC’s Statement of Operations? Did the company’s growth rate vary significantly between 2003 and 2007? Did CFC retain most of the loans originated for investment? What is your overall assessment of CFC’s financial performance between 2003 and 2007?

Compounded Annual Growth Rate for Net Profit (2003-2006) = ($ 2 674 846/$ 2 372 950) ^ (1/4)-1=3%

From 2003 to 2006, there was growth in net profits but in 2007, the company recorded a loss.

CAGR for Compensation from 2003 to 2007= (4,165,023/ 2,590,936) ˄ (1/5)-1=9.95%

From 2003 to 2007, there was a constant increase in the total compensation.

Overall, the loss that the company made in 2007 of $ 703538000 is small when compared to the profit $9773460000 from 2003 to 2006.

  1. Was CFC pursuing an ethical strategy? Were all of the CFC’s business practices ethical? Were CFS’s compensation practices ethical and in the best interest of shareholders? Did its lending practices harm borrowers? Is there anything unethical about its VIP loan program? To what extent, if any, were unethical strategies or business behavior a problem at CFC? To what extent, if any, was CFS’s CEO involved in unethical behavior?Evaluate Countrywide role in the subprime mortgage debacle

CFC was not pursuing an ethical strategy. The company advanced loans to people whom it knew could not be able to pay. It also made deals in order to be giving good ratings and continue misleading the market. Not all CFC’s business practices were ethical such as predatory lending.The compensation advanced to executives was not in the interest of shareholders as bonus pay out did not match the salary base. The lending practice made borrowers lose homes and money. VIP loan program was designed to help those close to the executive and this was wrong.  CFC was heavily involved in unethical business strategy such that it was able to corrupt politicians and rating agencies.

11.Recommendations to Bank of America Executives

  1. Are the subprime loans an unethical financial instrument, or are they ethical tools that were misused?

They are tools that were misused. They are supposed to help those in the category of low-income earners become home owners. However companies use absence of clear standards to misuse them.

  1. Discuss the ethical issues that caused the downfall of Countrywide Financial.

The company practiced predatory lending as well as corrupted rating agencies. It also hid important information from borrowers which eventually led to default.

  1. How should Bank of America deal with potential ethical and legal misconduct discovered at Countrywide?

It should come up with an ethical framework that guides on how loans are to be advanced. Any employee found breaching the laid down rules should be discharged and prosecuted in an court of law. Regulation inspection of Countrywide’s operations should be executed.