Unethical conduct in the US financial industry during global financial crisis (GFC)

The Global Financial Crises of 2008 cannot be attributed to a single cause or blamed
on an individual entity whose unethical behavior led to the downfall of an entire economy.
However, it was the deep rooted absence of ethics and morals within the whole society which
allowed different individuals to engage in excessive immoral behavior that eventually had a
negative impact on the world economy. Following are the unethical conduct in the US
financial industry during the global financial crises.
Firstly, relaxed government mandates and large mortgage companies’ switch to cheap
automated systems which although reduced time to process loan applications, also made it
less likely to detect unique risks associated to the creditworthiness of the applicants. As a
result, 40% of subprime loans were accepted by the automated systems. This increase in
number of loans for homeownership not only inflated prices for houses but also led to
overleveraging by these companies.
Secondly, to gather bonuses for themselves and gain additional funding for
investments of their organizations, some employees found creative ways to bundle mortgages
together and sold securities by using them as collateral. This would not have raised concerns
if all mortgages that were securitized were of good quality. However, some banks packaged
subprime mortgages with good ones and due to the high value of these securities, it became
impossible to separate subprime loans from good ones.
Thirdly, rating agencies overestimated the value of subprime mortgages and were
unsuccessful in protecting buyers by rating the bundles correctly based on the level of risk
they actually carried. They kept ethics aside and engaged in questionable practices that
yielded poor packages made to default as A-rated debt. This overvaluation of mortgage
backed securities by rating agencies caused U.S and global banks to spend more than they
could account, borrowing vast amounts of money at low rates in the short term to finance
their investment in mortgage back securities. This extensive issuance of mortgage backed
securities led to U.S household debt exceeding disposable income by one-third in 2006 and
remained at that level in 2007 (citation).
Moreover, Insurance companies, found little incentive to examine the bundles closely
and seeing the profitable prospects of the insurance policies, created credit default swaps. The
mortgage backed securities bundles could be sold as low risk securities partially because they
were backed by credit default swaps insurance.
 In addition, since the banks were successful in shifting high risk mortgages to others,
they found an incentive to write more subprime mortgages and take additional risk.
Therefore, they eventually approved applicants who neither had a stable employment nor had
the savings for down payments. Furthermore, lowered interest rates in response to the post
9/11 recession by the federal government further led to a surge in potential homeowners.
In conclusion, relaxed government policies that encouraged home ownership,
providing easy access to loans for subprime borrowers; overvaluation of bundled subprime
mortgages based on the expectation that housing prices would continue to escalate;
questionable trading practices on behalf of both borrowers and lenders, unethical conduct by
Wall Street operatives who used creative methods to demean the actual level of financial risk
of the products they were selling, in addition to lobbyists who convinced Congress to weaken
regulations and confine regulators, compensation structures by banks and mortgage
originators that prioritize short-term deal flow over long-term value creation; and a lack of
adequate capital holdings from banks and insurance companies to back the financial
commitments they were making, all resulted in what came to be known as the global financial
crises.

https://digitalcommons.sacredheart.edu/cgi/viewcontent.cgi?

article=1560&context=acadfest
 DeSousa (2020) states prior to the Global Financial Crises, bank provided short term,
unsecured loans that were properly monitored by the lenders. She further adds that such loans
were implemented in an ethical manner because the transactions were clear to the public and
such loans considered the common benefit of both, the customer and the bank. However,

In 2003 and 2004, with Fed’s low interest rates, banks saw an opportunity to offer easy
money to prospective homeowners and current homeowners, looking to refinance at lower
rates. Housing prices went from $469 billion in 2000 to $2.8 trillion in 2003 and banks
viewed it as an opportunity to gain greater returns and started to direct customers away from
standard 30-year, fixed-rate, 20% down, prime mortgage loan. Instead, they offered
adjustable rate loans, which presented very low-interest rates during the first few years of the
loan and explained rate increases were possible over the length of the loan. Homeowners
were often not adequately informed about the considerations associated with an adjustable-
rate loan. Most lenders did not properly explain the range of possible mortgage rates changes
during the loan period. Many lending professionals did not view it as their responsibility to
educate their clients and some may have rationalized their decisions as an altruist, in
providing segments of the population with an opportunity for homeownership that may not
otherwise have had the ability to obtain a traditional mortgage
the banking institutions grew in their resolve to profit and became increasingly creative
beyond the offerings of adjustable-rate loans. Subsequently, banks began to underwrite the
standards and focused on offering arrays of alternative subprime mortgage loans.
Securitization provided banks with the means to exclude these loans from their books and
neglect the reporting of any such transactions allowing the flexibility to gain back the capital
and proceed in providing more of the same, furthering the problem at exponential speed.

https://www.imf.org/~/media/Files/Publications/GFSR/2018/Oct/ch2/Doc/CH2.ashx
https://ideas.repec.org/a/kap/jbuset/v146y2017i4d10.1007_s10551-016-3052-7.html

Schoen, E. J. (2017). The 2007–2009 Financial Crisis: An Erosion of Ethics: A Case Study.

Journal of Business Ethics: JBE; Dordrecht, 146(4), 805–830.

http://dx.doi.org.sacredheart.idm.oclc.org/10.1007/s10551-016-3052-7