Sub-Prime Lending Ethics

Arinjit Chatterjee

Jia-dai Li

Jerry Perez

Sandyha Bhashyam

John Potusek

Ezequiel Gonzalez

Sub-Prime Lending Ethics Agenda

• Definition of Sub-Prime Lending

• Types of Sub-Prime Lending

• History

• Proponents of Sub-Prime Lending

• Criticisms of Sub-Prime Lending

What is Sub-Prime Lending?

Types of Sub-Prime Mortgage

• Adjustable Rate Mortgages - initial fixed rate, then followed by variable interest rates

• Interest only mortgages

• Minimum payment loans

• 80/20 Loans

• Stated Documentation

Sub-Prime Mortgage in U.S.

• 9% increase from 1996 through 2004

• 1/5 of the U.S. home loan market in 2006

Sub-Prime Mortgage History

• Depository Institutions Deregulation and Monetary control act (DIDMCA) of 1980

– made it possible to charge higher interest

– made it legal to charge fees.

• In 1982 the Alternative Mortgage Transaction Parity Act (AMTPA)

– permitted the use of variable interest rates and balloon payments.

Sub-Prime Mortgage History Contd.

• Tax Reform Act (TRA) 1986

– allowed for the consumer to deduct interest on mortgages for primary residences and one additional home

– helped to make high mortgage rates cheaper

– allowed mortgage debt cheaper than consumer debt.

Sub-Prime Mortgage History Contd.

• Mid 1990’s Sub-Prime mortgages, Sub-Prime

loans were originated mostly by non depository and mono line finance companies

– not backed by banking institutions

– the future performance of the sub prime in the long term was not know

Sub-Prime Mortgage History Contd.

• 1995 Sub-Prime Fixed Rate Mortgages were 62,000 – FRM originations peaking at almost 780,000

• Adjustable Rate Mortgages were 21,000 – ARM originations peaking over 866,000

• A housing bubble developed in the US during 2001-2006 – prices of homes increased and interest rates dropped

dramatically – lowest level in 40 years

• Crisis ensued between 2006 and 2007 – lenders filed for bankruptcies – accusations rose of actively encouraging fraudulent income

inflation on loan applications

Proponents of Sub-Prime Lending

Proponents of Sub-Prime Lending

• Gives credit to the people who would otherwise not have access to the credit market.

• Many buyers would never have had the opportunity to buy their own homes.

• These loans have contributed to the current record home ownership numbers.

Sub-Prime Loans

• Sub-Prime loans can generate greater profits for the lender/investors due to there higher interest rates and fees

Criticisms of Sub-Prime Lending

• “ Some lenders focused more on feeding the marketplace than on the quality of loans, in part because most of the risks that loans would go bad were passed to investors. As a result, mortgage applications with little documentation were vulnerable to misrepresentation or overestimation of repayment capacity by both lenders and borrowers.”

---Ben Bernanke, Chief of Federal Reserve

Criticisms of Sub-Prime Lending

Criticisms of sub-Prime Lending Contd.

• Twelve years ago, Lehman Brothers Holdings Inc. sent a vice president to California to check out First Alliance Mortgage Co.

• Critics say Wall Street firms helped create the mess by throwing so much money at the market that lenders had a growing incentive to push through insecure loans and mislead borrowers.

Criticisms of sub-Prime Lending Contd.

• Nationally, the mortgage industry has taken heat for its role in the sub-prime mortgage crunch.

• Capital markets operate on the basic premise of risk versus reward. The same goes for loans.

Sub-Prime Blame

• Where Were the Realtors?

• What Role Should Realtors Have Played in Warning About Risky Loans?

Sub-Prime Blame Contd.

• While much criticism has been leveled at sub-prime lenders and mortgage brokers, there has been little focus on the role of the realtors, even though the agent often serves as the homebuyer's chief advisor.

• Traditionally, agents are paid through a commission which is paid by the seller of 5% or 6% of the home's sales price.

Ethical Issues of Sub-Prime Lending

• 100% Financing

• Interest Only Loans

• Stated Income

• ARMs

• Commission Based Brokers

Ethical Issues of Sub-Prime Lending Contd.

• Borrowers

• Appraisers

• FED

• Wall Street

• Rating Agencies

QUESTIONS?