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The advent of mortgage-backed securities helped banks to distribute credit risk to investors, replenish their funds to make more loans, and gain from both transaction fees and interest. This practice created a moral hazard as banks only focused on processing mortgage transactions but ignored the credit quality (Lewis). The total amount of MBS issued almost tripled from 1996 to 2007, to $7.3 trillion (Demyanyk, Yuliya, Van Hmert, and Otto). However, as the number of defaults and foreclosures increased, the weakness of MBS was exposed. Eventually, the securitization markets started to close down in the spring of 2007 and nearly shut-down in the fall of 2008. The greed for gaining more money without assuming the risk generated by MBS led the subprime mortgage crisis.

There are two apparent ethical issues involved in this subprime mortgage crisis. First, the lending practices that lenders followed were unethical as they just focused on the number of loans they made and ignored the creditability of the borrowers. Though some people may think this is not an ethical issue, the irresponsible lending practices were unethical because lenders were just chasing for the big pool of money and forgot their responsibility as lenders. Here, the lenders are the banks who use the funds borrowed from federal to use in lending. During the lending practices, they didn’t take the responsibility to insure the creditability of borrowers to pay back the mortgage and correctly interpret the underlying risk. The mortgage qualification guidelines kept getting looser in order to produce more mortgages and more securities. NINA, an abbreviation of No Income No Assets loans came out stating that borrowers don’t need even to state any owned assets to make a loan. The only requirement for a mortgage was a credit score (Bernanke). Of course, the number of defaults and foreclosures increased which contributed to the presence of subprime mortgage crisis.

Secondly, the inaccurate credit rating is another ethical issue involved in this crisis. Credit rating agencies are responsible for giving justified rating for MBS based on the risks of subprime mortgage loans. This rating process was believed to reduce the risk of practices. However, because the credit rating agencies were paid by investment banks and other firms that organize and sell structured securities, the credit rating of MBS was inadequate and faulty.

The conflicts of interest for credit rating agencies caused an unethical rating for MBS, and misleading the investment of mortgage securities. These inaccurate credit ratings also contributed to the collapse of financial market.

Regarding the whole issue of subprime mortgage crisis, it seems that if each party involved in the subprime mortgage crisis would have taken more responsibility and been more conventional, they may have avoided this huge financial mess. These parties include the government, financial institutions, and individual borrowers. From the government side, one factor that they may have contributed to the deflating of the housing bubble is the raise of Fed funds rate between July 2004 and July 2006 (Federal Reserve).  This led to an increase in 1-year and 5-year ARM rates, making it more expensive for homeowners to pay their mortgage (Mastrobattista). As interest rates increased, housing prices started to drop, and it became riskier to speculate in housing (Max). Also, the government should have come up with more detailed regulation to control the business practices followed by credit rating agencies, investment banks, and securities treating entities.

            Besides government’s responsibility, financial institutions like investment banks and hedge funds should have been more responsible in the way that they treated their debt and funds. They should have been responsible for insuring the quality of the loans that they made, and correctly estimate their ability to absorb large loan defaults or MBS losses. One cause of the irresponsible practices followed by the investment banks was the inadequate compensation incentive. Investment banker incentive compensation was focused on fees generated from assembling financial products, rather than the performance and quality of those products and profits generated over time (Story).

             According to the responsibilities of government and financial insinuations, individuals should also be responsible when they make loans. They should consider their ability to pay back these loans. As everyone knows “There is no such thing as a free lunch”, mortgage borrowers should have noticed the huge debt they were going to face after the ARM passed the predetermined period of low interest payment.

            In conclusion, this subprime mortgage crisis demonstrated a lesson for the world. Every financial institution and company learned an expensive lessen from it. Every country learned what they should do and what they should avoid in the future. Moreover, each individual also learned the norm, the ethics, and the responsibilities that they need to follow and take in business practice. One important thing to remember is to not be too obsessed and greedy about anything.

Reference:

Bernanke, Ben S.  “Four Questions about the Financial Crisis.” Board of Governors of the

Federal Reserve System., 14 April 2009. Web. 14 April 2010.

newsevents/speech/bernanke20090414a.htm

Bush, George W. “President Bush’s Address to Nation.” CNNMoney.com, 24 Sep. 2008. Web. 1

            14 April 2010. 2008/09/24/news/economy/bushtranscript/index.

            htm.

Dmyanyk, Yuliya S., Van Hemert, Otto. “Understanding the Subprime Mortgage Crisis.” Social

Science Research Network., 5 Dec. 2008. Web. 14 April 2010. sol

3/papers.cfm?abstract_id=1020396

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