Ethics Theories Found in the Subprime Mortgage Crisis

The mid to late 1990s brought with it an unprecedented degree of prosperity in economies throughout the world. This was especially so in the United States where the real estate market was undergoing one of the largest boom cycles in the nation’s history.

Undergirding this real estate boom cycle, however, were mortgages being underwritten that were facilitating unscrupulous practices. Those practices included limited or no disclosure to potential buyers regarding interest rates that would increase significantly over a period of time. Insulating close scrutiny to potential problems in the real estate boom was an economy, spurred by the information revolution, which seemed to defy gravity (and negative prognostications).
Yet, within a decade, the country—indeed, large parts of most of the developed world—finds itself grappling with a economic crisis that has been precipitated by those “good intentions” of the early 1990s. This paper will address the ethics theories and implications as they relate to the subprime mortgage lending crisis in the United States. Though a U.S. phenomenon, various policy responses to the crisis (i.e. adjustments in interest rates by the Federal Board of Governors) have affected economies abroad that have interdependent relationships with the U.S. such as Europe and Asia. Thus, this crisis is now clearly a global-wide event and one warranting decisive leadership and appropriate public policy intervention.

More important, however, and for the purposes of this paper, an analysis of the ethics theories and perspectives involving the crisis is just as warranted as has been the many case studies thus far conducted regarding the ethical implications of the Enron and World Com financial debacles. It is particularly warranted because homeownership goes to heart of what the American Dream is all about. And before this event became a crisis, the country was experiencing an unprecedented rise in homeownerships due to public policy that sought, from a utilitarian perspective, to make homeownership available to as many people, from as many walks in life, as possible.

This writer and his wife were one those unsuspecting mortgage borrowers. Having started a catering company during the late 1990s and then, after modest success, deciding to expand to a franchise submarine sandwich restaurant, we took out second mortgages on two properties we owned. Within two years a spiraling downturn in the economy pushed us out of business and within a few more years of that, we found ourselves strapped with huge mortgage payments that played havoc with our personal finances (Childs, 2004). It has only been within the last year (having nearly lost both properties on more than one occasion) that we have begun to reach some level of stability.

Layered within the boom time in homeownership in the 1990s was the presence of a deceptively fragile economy, one that would bring an end to this boom time and be followed by soaring interest rates and an epidemic of foreclosures. In tandem with these developments are the presences of theories in ethics that can be used at each stage of this evolving situation that can be applied to better understand the dynamics of it and to offer preventive measures.

Through a search of the literature, this paper will offer insight into key areas involving this blight on the history of the U.S. mortgage industry. Included will be from the standpoint of a review of economic conditions that led up to these conditions; taking note of changes within the culture of both the corporate and political environments that made infractions of ethics increasingly likely, and also a look at how business and public policy leaders have begun implementing failsafe standards that will discourage such unethical practices from occurring in the future.
More specific to the purpose of this paper and its emphasis on ethics theories, however, the primary focus will be an analysis of the subprime mortgage crisis from the standpoint of the utilitarian perspective, the moral rights perspective (Kant’s categorical imperative), standards of justice (distributive) perspective, and standards of caring (ethics of care). In addition, as a shift takes place in the latter portion of the paper to address various solutions being offered in the public domain to address the subprime crisis, the ethics perspectives of communitarianism and altruism will also be factored in as applicable considerations.

The Utilitarian Modality

The mortgage crisis in the United States could well be seen as having first taken place due to some very well intended utilitarian motives on the parts of both the corporate world and public policy makers.

Utilitarianism is defined by Velasquez (2006) as that effort or initiative in which the most good is being sought to be accomplished on the behalf of the most amount of people. The concept itself emerges often in actions that are sought to blend both altruism with profit making incentives (e.g. the best of both worlds for a commerce driven, free enterprise form of government). Velasquez offers several examples where the good intentions of corporations and governments does have its limitations and can, in fact, return to actually present more problems than what it is trying to address. Such examples are frequently found in international business relationships. Specifically, the multinational corporation, GlaxoSmithKline (makers of an AIDS medicine), offered its medication to inhabitants in Sub-Saharan Africa but the costs were prohibitive and the medication did not reach some of the needier areas. This created a gap that had to be filled by more nimble, more entrepreneurially focused companies to move the medication out into these populations. The result has been that both a highly competitive and a protracted litigious situation has occurred as the deep pocketed GlaxoSmithKline has resisted having to make its initiative there more altruistically driven and less profit driven.

This event is a classic example of a company having a seemingly very good motive from a humanitarian standpoint to improve life for a distressed population but ultimately the greatest good needing to accomplished could not be because profit making motives took precedent. This is the struggle that Velasquez points out continues to emerge in such instances.

It is, then, in similar fashion that mortgage lenders and public policy makers entered into what seemed to be a very well intentioned initiative to bring the pride of homeownership to millions of Americans who might not otherwise be able to afford it.

During the early 1990s, a time when the country was experiencing an unprecedented peace time expansion, these stakeholders collaborated to create initiatives to facilitate homeownership on a wide scale basis in unprecedented fashion. This was during a time when corporations in particular were trying to create better financial relationships with minority communities, communities that were beginning to enter in to the economic mainstream in significant numbers, particularly Latinos (Zalewski, 2007). Presented in this situation was an embodiment of a block of potential consumers who could boost the economy at a rate parallel to how stock market prices were rising as a result of the boom in computer technology innovations.

Homeownership, in and of itself, creates a domino effect in the economy. When a home is purchased the owners need a variety of housing goods, they become taxpayers, and they need to send their children to schools. This then grows to an expanding need for public safety and dependence on public services and through all of these activities jobs are created, political positions have to be created to meet the public needs, and entrepreneurship is stimulated in the community. It is this dynamic that has played itself out since the founding of the free enterprise system (Schwartz, pp.3-21, 1995).

It was during this time that a number of economic incentives were created to spur and boost the lending of money to consumers for the purpose of increasing homeownership. The caveat to this was incentives for financial brokerages to offer to banks (via the form of securities) giving them greater leverage in increasing loans to high risk lenders.

Lucas (2004), in an interview with one of the authors of the legislation that would address irregularities in corporate responsibility, Paul Sarbanes, noted that providing such stimulus to the economy is walking a fine line. Sarbanes tells Lucas that part of government’s central responsibility is to make sure that there are significant opportunities and assists provided for the financial industry to help consumers improve their standard of living. To this extent, again, utilitarianism was clearly present at the early stages of this process when it came to the mortgage loan environment.

It would be later, however, following the 2001 debacle involving Enron and World Comm, where clear evidence of corporate level mismanagement took place, that a rethinking of the danger of unchecked utilitarianism would occur. It was in fact the Sarbanes Oxley legislation (more commonly known as SOX) that brought to light the need for transparency when it came to large scale financial transactions that appeared to be contributing to a greater good as well as being profitable (i.e. Enron had technically been in the business of helping reduce the costs of electricity by creating business models to deregulate delivery of its services throughout the 50 states). Grossman (2007) amplifies this position in noting how an absence of meaningful oversight in the corporate environment helped contribute to a climate of laxity that fueled the mortgage crisis in directly.

The utilitarian modality as it related to the mortgage lending industry did not just rest within the confines of the continental United States. Mouhammed (2008) reported quite recently how an interconnectedness of world economies has tightened in lockstep with the economic rise of the 1990s and the subsequent turbulence that continues to resonate in the post-9/11 era. He and Stephens and Quiglars (2007) point out that the hunger for profits ultimately overrode any altruistic benefits that might have initially fueled the policies for improving homeownership and an overall improvement in the number of entrepreneurs which was a hallmark of the 1990s pro-computer technology era.

What became evident as the encroachment of the mortgage crisis came into full bloom beginning in 2007 was that government intervention was necessary but first government had to reform itself when it came to financial initiatives. The passage of SOX legislation was one step but ultimately there had to be a rethinking of the model that had been used which, indirectly, encouraged a business climate that could have a duality of purpose: 1) to say it has a lofty goal of improving the quality of life for a segment of the population via resources or services (such as “affordable mortgages”) 2) yet, to be so driven by profits that even when it is clear that large parts of such an initiative is wrongheaded, there is an unwillingness to change course. This was the challenge as seen by Anderson (2005) and by Argandona (2003) as governments and business leaders come to realize that there is a powerful consequence when the prospect for business to maximize profits (and for government to create a significant short term stimulus to the economy) becomes irresistible--to intoxicating degrees. This is what happened in the utilitarian modality that is present in the mortgage lending matter; ultimately the principal stakeholders of government and business were on a runaway train of their own making and had no means of stopping it.

Yet, this cannot all be blamed on government and business. There are significant levels of blame to go around and some of that has to be directed towards the consumers themselves.

Moral Rights

In a free enterprise system a person has the opportunity to become as financially successful as his or her abilities and fortunes might enable that individual to be. This is also true for the extent to which an individual has a right to take on as much financial responsibility as he or she feels can be bore. In this sense, there is a clear indication of personal responsibility that must come in to play when it comes to a person taking on commitments that will require paying back money that is borrowed either from a person or from an institution.

In the case of a real estate mortgage, there is a clear responsibility that is undertaken requiring there to be a commitment in writing that the money being borrowed will be paid back. But there is also an implied requirement on the borrowers’ part to understand what he or she is getting in to. This means that the fine print in all the documents presented need to be read carefully and, if need be, legal consul should be consulted.

In the years leading up to the mortgage crisis there was present a standard boiler plate statement that was provided in mortgage documents and that was often mentioned by real estate professionals which essentially indicated that the interest rates being offered could be subject to change if the economy did. In this sense, nothing was hidden from consumers, per se. Such wording in a legal document is standard procedure and it would be reasonable to assume that the consumers signing such documents did understand the potential danger that this language was suggesting could be visited upon them.

In retrospect, however, such language was really quite similar to the standard, low level security procedures that were used at airports prior to the 9/11 terrorists attacks. The truth is, few people in all areas involved—consumers, business leaders, public policy leaders—could have forseen how horribly wrong the cavalier approach that was taken with mortgage lending was going to go. It was here, in fact, that a matter of moral rights emerged.

Velesquez (2006) defines a moral right as one that supersedes what might be considered individualized perceptions of right and wrong. A moral right goes to the heart of what defines not only the consequence of human action but the motivation. And an infraction of a moral right presupposes that even among the greedy and the ignorant there is an immutable protection that must be acknowledged and, if appropriate, a degree of redress must be provided.

Chi and Choudhury (2003) talk about this at length in their analysis of difficult moral dilemmas present when it comes to marketing consumer products. The authors note that while it is appropriate for a company designed to be a profit making one to engage its First Amendment rights in order to raise awareness about its product (or service), doing so also creates a certain degree of moral obligation that what is being presented is done so truthfully and honestly. LaCour-Little (1999) takes this further by pointing out that there have to considerations taken not only for moral aspects but also the ethnic and racial dynamic. It is this author’s contention that a business enterprise that is willing to pursue its profit making enterprise on behalf of a particular constituency (a targeted area such as a minority community) should have within its strategic plan boiler plate language that supports having ethical practices. LaCour-Little stops short of calling for sensitivity to moral issues but the author makes a strong case for the fact that ignoring basic ethical practices leads to a general deterioration of goodwill in a community and, defacto, can contribute to the moral destruction of that community by stifling the quality of life and contributing to blight and its ancillaries crime and proverty.

The subprime mortgage lending issue raised awareness about conditions existing within the consumer population that did support some of those elements of LaCour-Little’s thesis in this respect. Those who were most likely to gravitate to obtaining such mortgages were individuals who were living in financial circumstances that were either in a distressed situation or were borderline distressed. To this extent the offering of a mortgage at what would be considered an affordable rate was as much of a lure as it was an opportunity. To the extent that there was greed operating on the part of both parties (i.e. the mortgage lender and the borrower), this is a telling indicator of just how interrelated the moral issue was for all involved. It would appear that to some extent both the lenders and the borrowers capitulated to the darker natures of their personalities, both going down a road of financial uncertainty with their eyes wide open.

This can be a difficult premise to accept in a situation that is so clearly one that the majority news media has often characterized in David and Goliath terms (i.e. the consumer being the underdog David and the lenders and government backers of securities being the nemesis, Goliath). Yet, from a standpoint of the ethics of morality, there are no clear heroes or villains here. If there is any villain it might be in the form of frenetic government policies that had taken too great a risk on bolstering the computer technology industry (for fear of being outpaced by such major competitors as China and Japan) and as a result loosened the economy to allow such subtexts to occur like an opening up of the mortgage market to a flood of risky borrowers. And there again could be a moral element involved in this as the government not taking on such a Type A offensive approach at that early stage of the technology revolution during the 1990s might have resulted in the country being permanently behind in computer and information technology development. This does not mean that the ends justifies the means, but it does offer food for thought on just how the blame needs to be considered in this matter. Certainly government and the business community bear responsibility but it should not be forgotten that consumers contributed to their own demise to some extent.

Morgan and Jeffrey (1995) had begun a conversation long before the mortgage crisis in which they presupposed that the consumer who is in a vulnerable position has to be understood from a context beyond just the financial contribution he or she might make to advancing a business enterprise. This individual must be viewed, the authors noted, from a standpoint of being legal entities who contribute to the viability of a community and in being such have certain rights to be treated with fairness and consideration. But, they go on to point out, this same right has to be reciprocal and recognized for both business leaders and the policy makers of the community in order for there to be a proper and clear dispensation of right action and justice. To this extent, the authors address elements of distributive justice (Velasquz, 2006) as it relates to ethical treatment of individuals. But this is also significant from a moral standpoint because at the heart of their thesis is the clear sense that this form of justice should be viewed as a fundamental right, as something that should be bestowed simply because there are humane considerations that transcend the profit making motive.

It is important to include the moral element in this discussion about the ethics perspectives found in the mortgage crisis because doing so raises the discussion to a needed one about the longer term implications.

There is a great deal of discussion in the public domain about the moral decay of society via popular culture and a globalized news media and information culture, but what makes this discussion a meaningful one is the possibility of learning from experiences such as the mortgage crisis. With a fuller understanding of ethical implications in this matter, specifically the moral elements, there is the opportunity to advance discussions about there being more personal responsibility to be taken by consumers for the financial decisions that they make. And inversely, business leaders will have to accept that there is no invulnerability provided to them because of being driven by the profit-making incentive; being prone to making profits does not excuse engaging consumers—even willing consumers—with financial commitments that are going to be problematic in the long run.

It was with this consideration that Freyermuth (1998) advanced another pre-mortgage crisis discussion about consumerism and the dangers belying the engagement of vulnerable populations in noting that to accelerate a lending process is a type of passive aggressive entrapment. The consumer who has little in the way of sophistication in things financial will fall prey to processes that appear to expedite the obtainment of resources or services. But this same consumer will ultimately cost the lender three to five times what was invested to facilitate this relationship because in most instances there will be a breakdown in repaying. While these are difficult facts of life, Freyermuth noted, they serve as a warning sign for any lender who believes short term profits will offset later problems from such a consumer. And, such actions are ultimately morally problematic, Freyermuth also noted.

Distributive Justice

When the Enron and World Comm debacles came to public light, there was a hue and cry from many sectors of society and this ultimately resulted in there being criminal prosecutions made and the passing of some significant legislation at the federal level. What was less visible, though, were the hundreds of lawsuits that emerged and were filed on behalf of workers from those companies who had lost life savings and other lawsuits filed by various state and local law enforcement agencies against the companies and its interconnected accounting stakeholders. In these instances justice came about in waves, much of it driven by an outraged public and an enormous amount of media pressure.

This has not necessarily been the case in the mortgage crisis. Because the crisis itself emerged almost organically, that is, almost as a byproduct of some greater issues taking place with the economy (i.e. the increase in oil prices due to the war in Iraq and due to weather conditions that reflect developing global warming problems), this matter did not fully come to the public’s attention until it was a well developed crisis and very much spiraling out of control. The most noted development in the last six months was the removal of CEOs from major lenders of subprime mortgages such as Citigroup. But unlike the Enron and World Comm problems, where government intervention was slow coming, this crisis has created a wrap around of responses from both government and from the business community. What is less clear is the extent to which actual justice will be provided.

Velasquez talks about distributive justice as having clear properties of their being an orderly addressing of a clearly defined infraction against a person or group. This addressing or redress is played out in the form of legal dispensations that may come from intervention by a court system or within some other type of legal body, even a legislative one. These conditions are necessary, Velasquez points out, because there are certain infractions that must be addressed through legal means. And this is most often the case when there are victims from an action taken by entities that are much larger and more powerful than the individual. Such conditions warrant there being elements of advocacy in place that can exact degrees of justice equivalent to the infractions that have occurred.

Laczniak (1999) talked about distributive justice as a means of serving as a check and balance when it came to unscrupulous marketing practices. It is through the presence of this aspect of justice that a greater opportunity is presented to allow for full disclosure of flaws and problems in a product or service and thereby encourage reform. It was Laczniak’s condition that the most significant positive result deriving from distributive justice is for there to be reform that emerges either in the form policies that are flawed, practices, or both.

The mortgage crisis is already creating some degree of an environment of reform as a result of distributive justice because it has triggered legislation designed to assist lenders in offering emergency refinance packages for consumers who face foreclosure. This has become an issue of justice (just as it has become one of moral elements as well) because of the broader implications present. If there is a large scale defaulting of mortgages throughout the country the economy can only head further south than it already is (as is reflected by the weakening dollar and rise in gold and silver prices, both considered hedges against a pending recession).
Martin and Scogland (2008) offer an analysis about the mortgage crisis that essentially calls for sweeping modalities of intervention from the public sector in order to hold the line on there being a further wave of foreclosures. What this means from a distributive justice standpoint is that there is ample recognition of there being a wide scale human cost if there is not an organized response to addressing this problem. One of the favorable elements of distributive justice as opposed to the moral perspective or the ethics of care perspective (which is akin to the moral perspective) is that it engages institutional responses to recognized infractions that are inherently unethical. These responses are moved in to action often as part of a body of law and therefore are given some degree of authority that simply an individual or single organization taking a stand against something (i.e. a Ralph Nader against the environmental dangers caused by the Corvair, or consumer protection groups criticizing shoddy quality practices of China) could not be so immediately effective (although the parties in both examples were/are ultimately successfully in enacting positive changes).

Childs (2004) and Uzzin (1996) each called for there being a tightening of the legal parameters involved in lending practices in order to pre-empt the context of environments that would make it too easy for consumers to get in to debt. The authors expressed concern that one of the byproducts of a more driven, globally competitive economy, is that consumers would increasingly be the victims of business practices that might be inherently utilitarian driven but ultimately absent the failsafes to prevent them from going too far. It is in this sense that distributive justice does lean a heavier hand on the side of that person or institution that holds more of the basic power in a business/consumer relationship. It is to this extent that distributive justice holds to some of the foundational tenets that are found in Judeo-Christian principles and practices and in some of the other basic practices found in other religious teachings that call for fairness and a protecting of the less empowered party of a dispute.

Ethics of Care: Is it Warranted?

Velasquez offers a clear definition of ethics of care as being a condition, similar to the moral perspective, that calls for a superseding of what would be considered a normal position of commitment toward addressing an ethics infraction; essentially ethics of care means that an individuals or institution will go to whatever lengths are necessary to ensure that restitution is made or that potentially damaging consequences are insulated for innocent parties. Innocent parties, in this instance, are defined as a people or an individual that has come in to a condition of distress due to causes larger than themselves. Such circumstances would include situations where there have been natural or economic disasters on such a scale that without extraordinary intervention from external entities the survivability of the group or individual will be in question. To this extent, ethics of care is emblematic of being self sacrificing and by its very nature it is not seeking profits or some other form of remuneration as would be found in condition of utilitarianism and, to some extent, in situations where there is distributive justice. Ethics of care is really akin to the highest ideals of moral society and it is an act that offers hope in a society that is often all too focused on personal aggrandizement.

Griffin (2008) takes this discussion further in his analysis of what he calls servant leadership and its place as a leadership taxonomy that can restore conditions following an ethics breach. Although not speaking specifically of ethics of care, he assigns attention to self sacrificing principles as being of the higher order level to be found on the taxonomy. His argument is that an evolved leader will be presupposed to being self sacrificing because inherently there will be a desire to see the betterment of his people coming about, rather than seeing personal advancement for himself.

It is within this context that we must now look at the conditions wrought from the mortgage crisis. It becomes clear that any real and defining response to the mortgage crisis will have to be one that transcends the limited parameters of the utilitarian. And truly there can only be a certain extent of response that can be expected to come forth from the environment of justice. Surely it will be through a self sacrificing modality, an ethics of care that seeks no remuneration except for there to be a recovery for those who have been devastated by this problem, that lasting solutions will emerge.

The mortgage crisis has created a breakdown of trust at a level unprecedented in U.S. history. This break down in trust comes in the form of trust for the government (by both business leaders and consumers) and conversely there is also a break down of trust between business leaders and governments. To restore this there will need to be a re-evaluation of just what is the value of pressing forward with policies that contain inherent elements of caring for individuals. Smith and Walter (2006) and Heinze, Sibary, and Sikula (1999) take an approach toward this from the standpoint of assessing the regulatory framework that had been implemented following the Enron debacle. Their work is foundational in bringing forth this proposed discussion about caring for individuals, but it certainly does not go far enough. Martin (2002) moves closer to this in offering a virtue matrix that essentially offers a rubric that assesses in realistic proportions the extend to which a corporation is truly responsive to the social needs of the communities it serves.

Martin’s work is amplified by Freeman (1994) and Culpan and Trussel (2005) who both advanced the discussion that stakeholders must be active participants in any structuring of a meaningful policy of ethical standards. Implied in all of these works is the self sacrificing element that is advanced by Griffin.

The mortgage crisis did not begin in a vacuum and this problem will not be arrested within a vacuum-type circumstance. It will require significant collaborative relationships from a slew of stakeholders from a range of constituencies, but inherent in this initiative must be wiliness to address—to meet—this problem at the core moral level. It will then be from the ethics of care standpoint that a most appropriate leadership direction should be taken, going forward.

Conclusion and a Call to Action

The pace in which the globalization of business has increased exponentially over the last two decades and it is this writer’s contention that this has created an environment ripe for ethical abuses. The mortgage crisis is one of the examples of this. And what makes the mortgage crisis a particularly onerous one is that it is tied to the very essence of the American Dream; that is for a family to gain economic success through being home owners (Childs, 2004).

The real estate boom of the 1990s drew in lower income people into the being among the community of homeowners than ever before. Inversely, when the real estate market reached the bust cycle, more middle and lower income people faced home foreclosures at a rate only surpassed by the Great Depression of the 1930s.

This paper analyzed the mortgage crisis and its ethics considerations from the standpoint of conditions leading to the crisis, its consequences, and from the standpoint of preventive measures being put in place to address future occurrences of this kind. This paper addressed specific theories of ethics and their varied implications in this crisis and reviewed how closer attention to accountability in this area could encourage ethics considerations to be more embedded in corporate and government culture.

As of the writing of this paper, the U.S. Secretary of Housing has indicated that the government will take direct action to make sure that, going forward, Congress will be strongly encouraged to create a national licensing system for mortgage brokers and that there be more open disclosure of risks on mortgage investments. These are favorable developments and it is hoped they will continue for the sake of restoring the health of the U.S. economy.

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