01 September 2013
Unethical Mortgage Lending and the Collapse of the American Economy
Living in an era of economic uncertainty is an abysmal proposition that many of us thought improbable. However, we find ourselves in the midst of the worst financial quagmire since the Great Depression of the 1920’s. Across the United States, businesses are down-sizing and even closing the doors of peripheral branches. In realizing that there is no way to return to a period of economic prosperity America once enjoyed, it is important to look at the causes of its demise. While there are myriad causes for America’s financial collapse, it is important to focus on the role ...view middle of the document...
However, mortgage brokers are paid on the quantity of loans they initiated, as opposed to the quality of the loans (Curtis 2). This resulted in a higher production rate, but with fewer mortgages that could actually be considered “good” paper, meaning that the borrower could pay the loan back within the terms of the agreement (Curtis 2). Whether the borrower could adhere to the terms of the agreement or not, it was never the bank’s intention to hold that paper on the ledger as they looked to leverage their balance sheets. Leveraging a balance sheet gives an institution the ability to re-use and their lending capacity over and over again. This was accomplished by pooling these mortgages and selling them to investors (Curtis 2).
These actions were partly caused by the deregulation and subsequent concentration of the banking industry brought about by the Glass-Steagall Act of 1933, which unintentionally helped to fragment the banking industry, as well as limit its political clout. The main purpose, however, was to protect depositors from liability should the institutions default on the bonds they owed (Zingales 1). As time progressed, the limitations created by these regulations began to dissolve, and the number of institutions also decreased, while concentration increased. In 1980, there were 14,434 banks in the U.S. This was roughly the same amount as when the Glass-Steagall Act was passed. By 1990, there were 12,347, and by 2009, there were less than 7,100 (Zingales 1).
The concentration of the banking industry, and the issues with the current incarnation of the subprime lending market, were not the only causes of the financial collapse. The failure of the so-called “repo market” also played a large role in America’s financial instability. The term “repo” come from “repurchase agreements,” which are short-term loans (usually overnight) which require the borrower to pledge collateral (usually bonds) in return for cash; the collateral is then “repurchased” through repayment of the loan (Samuelson 1). While no one knows for certain the actual value or size of the repo market, it is estimated that at any given time, this market holds a value of around $10 trillion (Samuelson 1). By comparison, according to a U.S. Bureau of Economic Analysis release, the Gross Domestic Product for 2012 was only slightly larger than this, coming in at approximately $16.245 trillion (U.S. Bureau of Economic Analysis 1). Banks would rely heavily on repo loans, until the subprime securities began to lose value. This caused many of the repo loans to become limited, or vanish altogether. Banks such as Lehman Brothers and Bear Stearns were then deprived of credit, and failed (Samuelson 1). This also left other banks vulnerable to the same epic failure. One can easily see how this could create problems in the financial system.
These financial practices are unethical to the point that they cost individual investors, and the American taxpayers, countless dollars. The...