Part 1. Personal Experiences of a Househunter
Back in winter of 2008-2009, as many people were losing their homes due to subprime mortgages, I was looking for another place to stay. A number of homes that I found were in Englewood area about 10 miles south of Denver, Colorado, pretty close to where I worked. At the time, quite a few homes were available for purchase or rent due to the large numbers of defaults that had just taken place with the banks. One of the homes located fairly close to where I worked had a remarkable price attached to it – it was a four bedroom, 2.5 bathroom, with more than 2000 sqft floorspace home being offered for $1250 per month as a rent-to-own. Nearly every other home I saw in this region as a rent-to-own went for $1600 to $2400 per month.
So I decided to look up everything I could about this home and the real estate company making the offer curious as to why the price was so tempting.
It is often possible to purchase homes at low prices due to home owners recently deceased and a relative trying to sell the place as quickly as possible. It is also possible for a home to go into default due to a combination of owner, court and lender financial problems, or a legal case such as a divorce, or a situation in which the previous owner was not only went into default but also had damaged the home considerably or emptied it of basic accessories like a refrigerator, stove, and furnace.
In the weeks ahead I found that none of these were the case for this home or its company and financiers. It ended up the real estate company selling this home was a recently developed partnership consisting of 3 to 5 people, with a very crude and limited webpage about the company and the houses it offered for sale. Each of the workers for this company had his/her own unique history that could be reviewed by exploring the internet. Their phone numbers were cell phone numbers, and lacked space for leaving a message.
It ended up that this group business was a little more than a year old, was presided a young individual with just a few years of real estate experience, with a woman as V.P. whose primary employment in the region during this same period was as a credit card collection agent and editor of a monthly newsletter on managing a collection agency. There were also two financial advisors in the partnership, who filled out the paperwork and approved the final mortgages. They were bank employees who worked for separate banks, each with less than 2 years of history and no history that could be assessed.
As if these features alone were not enough to dissuade me from trusting the offer the company had made, I decided to trace its history and found out that it turned out that this company was licensed to operate through an application filed in Phoenix Arizona, and had no Denver LLP or license. Prior to Denver, the president’s name was attached to another real estate partnership two years earlier in Portland, Oregon. This company in turn was preceded by yet another one in California, all of this according to the President’s own CV posted on Linked In and his accessible photos and such posted on MySpace. Finally, his CV revealed where he went to High School, and when this was researched I found out that this school was in Texas, where had a traditional Latino/indigenous name with two plus surnames. The last of these names he removed when he moved to Portland, and was no longer using with the business in Denver.
Further review of the company President by way of the social media sites showed that he spent 4 to 6 months per year in tropical settings on “vacation” and a lot of time in the winter skiing in the mountains, close to Portland, Oregon. His personal messages revealed a lot as well, along with the ample amount of photos he posted revealing all of his recent ventures. Finally, with my trust now at a minimum, I contact the Better Business Bureau sites for several states to find out more about his business. These sites stated that businesses like this were supported or recommended by any state or regional BBB, he was not on the supported business/partnership lists, and his partnership was not supported by either Portland, Oregon or Denver, Colorado.
Most importantly, due to some of the events mentioned that took place in Portland, Oregon, it seemed likely that this partnership was searching for clients of low income status, individuals in desperate need of a home and an affordable mortgage. Depending upon how the mortgage contract was written, I soon found out, the approximately $50,000 value in equity assigned to this home by the financial advisor/ employee in turn had a clause that enabled it to be forfeited to the lender (President or his assistant), were the individual to go into default with the loan.
Of course, I never ventured back into this potential rent-to-own opportunity.
Part 2. Experience and Insight
My personal experiences with the Denver company were fortunately very limited. Unfortunately that is not always to case for many others. Companies like this success because of the variety of potential victims out there.
I interpret this experience as a real life example of the problems that do exist within the financial system. There are just not enough services out there to prevent companies from making their incredible offers. This all took place in 2007, when according to the writings of Gilbert (2011), Watkins (2011) and Thiel et al. (2012), the opportunities for purchasing a home or taking out a personal loan seemed too good to be true, and subprime failure was about to take its toll on the national economy.
The question left unanswered is ‘who’s fault is it?’ The lenders’ the governments’ or the homebuyers’?
In Belás (2013, p114, cited from Rendtorff, J., D., Mattson, J., 2012), the following “ethical principles” are defined as essential to moral social practice by lenders such as the fly-by-night company in Phoenix/Denver: enablement of autonomy for the client; the practice of honesty and dignity by the lender; recognition and attentiveness paid to the potential vulnerabilities involving the client; and the fair and complete access to all of the services on behalf of the customer receiving the loan. More than a decade earlier, Moir (2001) made an attempt to define corporate social responsibility at all levels. How these problems were linked to corporate responsibility produced a valuable summary article on this topic Decker (2004). Decker’s article was published just a year before the subprime loans problem became a major problem.
With his article, Moir defined several levels of responsibility, referring to them in respect to how they were first defined by the World Business Council for Sustainable Development on Corporate Social Responsibility (World Business Council for Sustainable Development (WBCSD) 2000). Each of these WBCSD statements could be compared and contrasted with the ethical principles defined by Belás (2013) and Rendtorff and Mattson (2012). According to Moir, the actions of business ensued with the following primarily in mind: defining business benefits and shareholder values, controlling risks, identifying market opportunities, improving reputation, and maintaining public support (1999 in Moir, 2001). Generally speaking, it is this last item that was primarily responsible for failure of subprime loans.
Part 3. Knowing thy Enemy
There are two basic ways that subprime loans can be generated. By understanding these methods, we are more able to understand and predict where and when the problems with subprime loans will most likely exist.
The first way that problems ensue is through providing of loans to individuals whom the financier already knows do not meet the most basic prime lending requirements. The lender, in spite of this potential risk, decides to make the loan available to the applicant anyway, regardless of the risk that exists at both ends. Normally, we might consider this a problem with the two sources of origination—the lender and the client. However, the lender has several ways to react to the failure of this loan, by engaging in behaviors and actions that more than likely to be unethical in nature. The most important of these is the way a company manages a failed or defaulted loan, such as by re-packaging it in order to sell it to another company. This enables the original source for the loan to receive a partial return on the original loan—better than nothing. But if this action were to be repeated, with the second company now repackaging and reselling its loan to a third vendor, sooner or later this program will reach its limit, meaning the previous owner and subsequent buyer no longer find any benefit in passing on the risk to the next company. Gilbert refers to this behavior as predatory lending (Gilbert 2011, 99).
The second way a subprime loan can be generated is by simple carelessness engaged in by the loaner (Gilbert, 2011, 101). For this scenario, the loaner has engaged in every basic step required to make sure the recipient qualifies for the loan for the most part, except for one or two final steps needed such as following up on the applicant’s income claims. This involves a person applying for a loan as overstating or estimating his/her earnings and/or holdings and belongings. In the case of earning, an $80,000 per year individual who received an unusual bonus of $20,000, making the total earnings for the year $100,000, might either “fudge” these numbers on his paperwork by claiming an income of $100,000, later mentioning the bonus separately thereby implying a $120,000 annual income instead. Alternatively, the individual might simply state this income in spite of knowing that the job position and offer might soon become a past asset, due to an expected internal job change taking place.
This latter example approximates the case given involving the Denver, Colorado company that I reviewed back in 2008.
These two methods can result in generous loan offerings to individuals who normally cannot manage loans of such size. Such a loan then begins with payment plan that seems worthy to pursue, but in the long run becomes the primary reason for any failure that follows. Once the temporary low interest rate finally reaches its end about 6 or 12 months later, enough time has passed for the original lender to be long gone if necessary, but still in contact with the original financiers in case his/her $50,000 in equity becomes collectible.
The WBCSD review of CSR during its initial stages is accessible at http://research.dnv.com/csr/PW_Tools/PWD/1/00/L/1-00-L-2001-01-0/lib2001/WBCSD_Making_Good_Business_Sense.pdf
The moral issue related to this case focuses on the irresponsible behaviors of the lenders and financiers, responsibilities linked to what is now referred to as “Corporate Social Responsibility” (CSR) (World Business Council for Sustainable Development 2000). CSR is a moral rule put into place that states that unethical practices are in general not allowed to be performed by business, either passively or actively. A common example of such a practice mentioned by Gilbert (2011, 103-104) is the offer of a very affordable repayment program, only to replace it with a higher interest rate once a certain amount of time has passed.
The unfortunate thing about all of these activities is it is very hard to assign blame to events that are well composed in writing, and in immaculate detail. The complete descriptions of these processes for engaging in these financial transfers makes it difficult for companies and legal agents to assign blame to a company that is a lender. Referred to as the “Goldman Rule”, a rule that is in favor of business and is hard to find fault with, such a practice has led to the establishment of number of policies being established to monitor these behaviors (U.S. Senate, 2010). More policies, rules and laws mean more actions that need to be checked, and cross-checked, through activities and paperwork that seem to never end.
In the end, determining how effective these processes are going to be is still unresearched territory. Personally, I take all of these problems with limited concern, so long as I am not a victim of such trickery and deceptions. But that also is not being completely social responsible about this problem. Perhaps with time, corporations and partnerships will become more trustworthy than the fly-by-night real estate partnership in Denver, Colorado. I’d rather pay for my own ski trips and beachside vacations, not those of a blatantly young and distrustful businessman.
Part 4. Bibliography
Belás, J. (2013). The Impact of the Financial Crisis on Business Ethics in the Banking Sector: A Case Study from Slovakia. Review of Economic Perspectives – Národohospodářský Obzor, 13(3), 111–131, DOI: 10.2478/revecp-2013-0004
Decker, O.S. (2004). Corporate Social Responsibility and Structural Change in Financial Services. Managerial Auditing Journal. 19(6) p. 712-728.
Gilbert, J. (2011). Moral Duties in Business and Their Societal Impacts: The Case of the Subprime Lending Mess. Business & Society Review (00453609), 116(1), 87-107. doi:10.1111/j.1467-8594.2011.00378.x
Hu, H. T. C. (2012). Too Complex to Depict? Innovation, “Pure Information,” and the SEC Disclosure Plan. 90(7), Texas Law Review. Symposium. Reshaping Capital markets & Institutions: Twenty Years On. Accessed at http://www.texaslrev.com/90-texas-l-rev-1601/
Moir, L. (2001) What do we mean by Corporate Social Responsibility? Corporate Governance, 1(1), 16-22. Reviewed at https://dspace.lib.cranfield.ac.uk/bitstream/1826/3256/1/What%20do%20we%20mean%20by%20corporate%20social%20responsibility-2001.pdf?origin=publication_detail.
Rendtorff, J., D., Mattson, J. (2012). Ethics in the bank internet encounter: an explorative study. Journal of Information, Communication and Ethics in Society, Vol. 10, Issue 1, pp. 36-51.
Thiel, C., Bagdasarov, Z., Harkrider, L., Johnson, J., & Mumford, M. (2012). Leader Ethical Decision-Making in Organizations: Strategies for Sensemaking. Journal Of Business Ethics, 107(1), 49-64. doi:10.1007/s10551-012-1299-1
US Senate, (2010). Brief Summary of The Dodd-Frank Wall Street Reform and Consumer Protection Act http://www.banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf
Watkins, J. P. (2011). Banking Ethics and the Goldman Rule. Journal Of Economic Issues (M.E. Sharpe Inc.), 45(2), 363-372. doi:10.2753/JEI0021-3624450213
World Business Council for Sustainable Development. 1999. Corporate Social Responsibility, Conches-Geneva, Switzerland: World Business Council for Sustainable Development.
World Business Council for Sustainable Development. 2000. Corporate Social responsibility: Making Good Business Sense. Conches-Geneva, Switzerland: World Business Council for Sustainable Development. Accessed at http://research.dnv.com/csr/PW_Tools/PWD/1/00/L/1-00-L-2001-01-0/lib2001/WBCSD_Making_Good_Business_Sense.pdf