CASE 3

CASE 3

Countrywide Financial: The Subprime Meltdown

The subprime market flourished in the early 2000s. High growth in this sector can be attributed to the high growth of the housing market, historically low interest rates, and low delinquency rates. Houses were constructed, and their values appreciated at the fastest rates in the history of the United States. However, the housing bubble burst in 2006, sending the prices of homes plummeting in many regions of the United States.

The passage of the Equal Credit Opportunity Act of 1974 allowed more consumers to apply for loans. This act, while not guaranteeing all applicants loans, ensured that consumers could not be rejected on the basis of sex, race, national origin, or any other discriminatory information. The act also gave specific guidelines on what lenders could and could not do or ask. While not all consumers who applied for loans received one, loan officers found that there were more opportunities to make money through commissions by forcing a loan through. It is possible that poor underwriting procedures increased.

The current subprime crisis was created by high rates of delinquency and foreclosures of mortgages, largely because high-risk consumers were given loans they could not afford. Of the 6 million American consumers with subprime loans, more than one-third of those loans are in danger of ending in foreclosure. According to the Mortgage Bankers Association, subprime loans comprise 13.7 per cent of all loans (the industry has approximately $10.7 trillion in outstanding debt for all loans, and over $600 billion for subprime loans). Many attribute the large numbers of defaults and foreclosures to adjustable-rate mortgages. 

Angelo Mozilo did not blame himself for the poor performance of Countrywide, but rather blamed regulators, rating agencies, legislators, and the media. Shareholders upset with Mozilo felt he did not actively assess the risk into which Countrywide was buying. David Sambol likely does not blame himself either. In fact, considering the damage his program did to the housing industry as a whole, he recived virtually no punishment. While lawsuits are pending, both Mozilo and Sambol do not seem to realize the severity of their actions, or the problems they caused for millions of homeowners who faced or are facing foreclosure. 

To augment this case and to provide some background on the Wall Street financial crisis, the subprime housing meltdown, and the causes of the recession, instructors may want to show the following episode of Frontline (http://www.pbs.org/wgbh/pages/frontline/meltdown/), which is available on PBS’s website. The show is one hour long and is available in its entirety. It helps to clearly lay out what went wrong with some of these financial companies, and it underscores the high level of risk in which each was engaged. Accompanying the show, PBS has created a supplementary lesson guide for those instructors interested in taking their students’ learning further (http://www.pbs.org/wgbh/pages/frontline/teach/meltdown/).

Instructors may encourage discussions on the rights of the individual, the company, and the government as it relates to the subprime issue.

DISCUSSION

1. Are subprime loans an unethical financial instrument, or are they ethical but misused in a way that created ethical issues?

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

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