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					 Subprime Lending-
Illegal, Unethical, or Both?
        Presented by:

        Shady Business
Subprime lending
    The practice of making
     loans to borrowers who do
     not qualify for the best
     market interest rates
     because of their deficient
     credit history or lack of
     credit history.

   History (1)
   Evolved with the realization of a demand in the
    marketplace and businesses providing a supply
    to meet it.
   Bankruptcies and consumer proposals being
    widely accessible, a constantly fluctuating
    economic environment.

History (2)
• Subprime mortgage lending industry originated at $173 billion in
  loans in 2001 (11 % of total mortgage originations) .
• Loans have been made to borrowers with blemished—or
  nonexistent—credit records.
• Borrowers are charged a higher fee to compensate for the greater
  risk of delinquency and the higher costs of loan servicing and
• Financial firms re-package loans as collateralized debt obligations
  (CDO) and improved their profits by 20% to 50%.

Subprime Lending Credit instruments:
         Subprime mortgages
         Subprime car loans
         Subprime credit cards

Subprime borrowers have:
• Bad credit (credit scores under 620)
• Lack of credit history
• Low income
• Poor debt to income ratios
• Large loans relative to the securing
  property (high LTV ratio)
• Maxed out credit cards

"If someone wants to buy rotten fruit, there's going
  to be someone willing to sell them rotten fruit."
Subprime lending is risky for both lenders
  and borrowers due to:
     High interest rates
     Poor credit history
     Adverse financial situations usually associated with
      Sub-prime applicants

Predatory lending practices
      Subprime loan designed for people w/ weak credit scores or
       no credit history
      Seek naive borrowers
      Lie to borrowers regarding actual credit rating
      Pressure home owners to re-finance frequently charging hi-
       closing fees and rolling closing cost into mortgage
      Deter clients from shopping for other mortgages lenders
       because to many inquires will hurt credit score
      Non-disclosure of :
           That broker is being paid by both lender and borrower
           Pre-payment penalty
           All fees associated

Predatory lending practices by subprime
  lending companies leads to:
  • default
  • seizure of collateral
  • foreclosure

 “Some 2.4 million homeowners are in
 danger of losing their homes, many
 because of bad Subprime loans.”
The majority of subprime loans are refinance loans

                                               The Subprime home
                                                refinance market
                                                ranged from 74 % of
                                                Sub-prime loans in
                                                1996 to 65 % of Sub-
                                                prime loans in 2000

                                            "The Blame Game story about the
                                            rise in foreclosures omitted a very
                                            culpable participant, the borrower.”
Survey conducted by AARP (1)
(American Association of Retired Persons)
                     Use of Broker or Lender

                                      • 53% of subprime
                                        borrowers used a broker
                                      • 34% of Prime borrowers
                                        used a broker

                                        “Lenders made far too many loans
                                        to borrowers they knew, or should
                                         have known, would not be able to
                                                 pay them back.”

Survey conducted by AARP (2)
                  Characteristics of loan
                                      Subprime borrowers
                                      • Low monthly payments
                                      • Loan approval
                                      • Quick turnaround

                                      Interest rate and
                                        mortgage terms were
                                        least important.
Survey conducted by AARP (3)                               12
         Familiarity with the mortgage process

                               Subprime borrowers were less
                                likely to be familiar with:
                                 • Credit records
                                 • Loan qualification
                                 • Mortgage rates and costs
                                 • Types of mortgages available
                                 • Basic mortgage terms

Survey conducted by AARP (4)                                  13
Summary of findings (1)
1. AARP studies have shown that a
   significantly greater percentage of
   Sub-prime loans are held by older
   borrowers who are:
     Widowed
     Female
     Black
     Less educated

2. There is concern about the increasing
   percentage of foreclosures associated
   with Sub-prime mortgage lending.

 Survey conducted by AARP (5)              14
Summary of findings: (2)
  3. These older borrowers…
     Used a broker to obtain their current loan.
     Had the lender/broker initiate the contact.
     Responded to ―guaranteed approval‖ advertisements.
     Refinanced two or more times within the past three years.
     Were dissatisfied with their loans.
     Received a loan different from what they expected.

Survey conducted by AARP (6)
Decrease in stock price/ shareholder value
 of major financial institutions related to
 Subprime loans:
                           Stock Price
                       Jan-07      Jan-08    Decrease
  Citi Group       $    55.13    $   24.96    55%
  Merrill          $    93.56    $   49.45    47%
  Morgan Stanley   $    82.79    $   45.25    42%
  UBS              $    63.01    $   40.89    35%
  HSBC             $    91.83    $   73.80    20%

Write-downs due to the subprime mortgage crisis
                           Merrill Lynch- $22.4B
                           Citigroup- $19.9B
                           UBS-$14.4B
                           Morgan Stanley- $9.4B
                           HSBC-$7.5B
                           Other (12+firms)$34.2B

                            Total:   $107.8B

Subprime lending is unethical.
The Metaphysics of Subprime Lending (1)
  Reality often creates situations where behavior sometimes is
  compromised or rationalized during the conduct of business.

Subprime lenders created new instruments to entice weaker
  borrowers during the slow down in the mortgage industry.

 •   Stated Income Loans
 •   Piggy back loans
 •   Option ARMS loans

 All parties saw these instruments as an opportunity that could
     benefit all parties.
The Metaphysics of Subprime Lending (2)
   Brokers saw it as a way to
    make more money by selling
    loans which had a higher Yield
    Spread Premium.

   Lenders saw the possibility of
    making more money by
    producing loans with higher
    fees to cover their risk.

   It seemed like a great idea but
    GREED took over.
Ethical behavior occurs in a framework of behavior
  shaped by various concepts including:
    Justice. An organization gives fair treatment to an individual.
    Loyalty. One party can count on the support of another party.
    Truth. Facts are interpreted correctly and shared openly.
In order for Subprime lending to be ethical all three
   concepts must be met.

                       Sub Prime Lending unethical

Concept of Justice : NOT MET (1)
     Justice is interpreted in an ethical framework
       in terms of three factors.
     Does a person or organization:

       •Belief.  Hold a belief that
       would deprive others of justice?

       •Action. Act upon that belief?

       •Truth. Acknowledge that
       belief or action when
       questioned about it?

Concept of Justice : NOT MET (2)
Brokers are Unjust because of their belief and action of
  promoting loans that are:
    NOT  beneficial for the borrowers.
    ONLY beneficial to both the lenders and brokers.

    Have HIGHER YSP (yield spread premium) which is the money paid to
     the broker.
Also, brokers are not truthful in disclosing the YSP information
   and all the hidden fees.
Concept of Loyalty : NOT MET (1)
 Lack of Loyalty between the brokers and borrowers

     Since brokers are paid by both the borrower and lender,
      brokers have tried to get the:
         highest rate for the lender
         highest rate (non-beneficial) for the borrower.

     This is unethical because the borrower is trusting that
      their broker is helping get the best rate.
     Broker is not being loyal to the borrower.

Concept of Loyalty : NOT MET (2)
    Loyalty. One party can count on the support
     of another party.
         Not so, in the subprime crisis. Lenders are putting
          up their hands and saying, ―You signed on the
          dotted line.‖

Concept of Truth : NOT MET (1)
Untruthfulness between broker and borrower
       Information NOT DISCLOSED to borrower:
            Pre-payment penalty information
            Broker is being paid by both lender and borrower
            All fees associated (YSP) or not disclosed up front
     Lie to borrowers regarding their actual credit rating.
     Deter borrowers from shopping for other mortgages.

     Brokers stating that too many inquires will hurt credit score.

Concept of Truth : NOT MET (2)
   Untruthfulness between Lender/Borrower

      Borrower reporting higher income
      claims on the loan applications.

      Unfortunatelythe ―Stated Income‖
      loans allow borrowers to state their
      income without the lender verifying
      the information.

      Itassumes the borrower will be
    Subprime lending is unethical because the three
   Justice. An organization gives fair treatment to an individual.
   Loyalty. One party can count on the support of another party.
   Truth. Facts are interpreted correctly and shared openly.

    are not met.

   Respect - the subprime lenders are not
    respecting the borrowers.
       Lack of Respect. This occurs when the organization
        treats people as means to an end.
   Equity - Not being fair and just to all parties. By
    not providing an education as to what other
    products are available and what borrowers
    would be eligible for, is:
 UNETHICAL,                but not ILLEGAL              29
Is the mortgage industry behavior ethical?
  •No, behaving immorally: A person exhibits behaviors
  that offend members of a community because they
  conform to low ideals.
  •Conflict with what is right and what is perceived as
  right. This is where metaphysics come into play.
  •The subprime industry opinion of what is right or
  wrong is being compromised by dollar $.
  •It might not be illegal, but it is definitely unethical.

……………………the dotted line

Is Subprime Lending legal?
 Factors   to consider:
      The written contractual agreement
      The lack of education by the borrower

      The lender’s methods of advertisement

      The degree of negligence of every party

   The Written Contractual Agreement (1)
          A binding agreement between two or more persons or
          Basic Requirements of Contracts:
                 Offer and Acceptance

                 Consideration

                 Competent Parties

                 Legal Purpose

   The Written Contractual
    Agreement (2)
          If the Offer is misleading and
           does not represent the written
           contract then this can be seen
           as fraudulent or an act of
           negligence. These actions
           would then be illegal.

          If all parties fulfill the basic
           requirements of the contract
           then the actions are legal.

   Lack of Education by Borrower

       Is the lack of education by the borrower an act of
        negligence on his or her part.?
       Should the borrower be legally responsible to be
        educated when signing a contract or is it the
        responsibility of the lender to educate the borrower?   35
The   Lender’s Methods of Advertisement
         •The borrower must be aware of false information
         being advertised by the lender
         •Target minorities and debt-strapped families
         •Target low-income and low-wealth
         •Hybrid mortgages, start with fixed rate, but shift to
         higher ARM with multiple rate increases
         •Disclosure to extent of the law

Subprime Competition (1)
Subprime Mortgage companies compete with
each other and spend tremendous amounts of
money on door to door marketing.

    Subprime Competition (2)
   Not to save the customer money, but because,
    according to Fannie Mae,
    -Half of the customers who receive subprime products
    would be eligible for a regular prime mortgage.
    -This could mean a loan up to four percentage points
    less - a tremendous savings for the borrower.

   The degree of Negligence of every party
       Negligence is the failure of a party to
        exercise a proper degree of care in a given
            Subprime lenders can act negligent if
             withholding certain information towards the
            The lenient standards in the past had omission
             seem unethical yet legal.

Has subprime lending been LEGAL?

   Characteristics of a Subprime loan:
       High Interest Rates
       Hidden Fees
       Unnecessary Financing
       Deceptive Terms and Marketing Practices
       Some pro subprime lenders argue that, except for fraud, false
        information or faked signatures -- there is no such thing as
        predatory lending, because borrowers are not forced to take the

Has Subprime Lending been LEGAL?

    There are no laws that state
     otherwise. The lenders set the
     standards and rules for the
     Subprime loans.

    These elements included higher
     interest rate and fees to cover
     their risk.

    They unfortunately lowered the
     standard of the borrowers too
     much and just got loan happy.
Greed took over everyone.

Some actions by the Brokers
were illegal (Not disclosing pre-
payment penalties, fees
information, not being truthful to
the borrowers regarding credit
scores and the best alternatives
for the borrowers)

Borrowers lied to the lenders
regarding their income.
   As long as the lenders were not dishonest, lied
    about the terms, or forced a borrower to sign for
    a loan:
       The lenders did not do anything illegal.
       To stretch this even further, the borrowers actually
        have committed a breach of contract for not making
        the payments on their loans.
       Sounds ridiculous, but as long as the borrower signed
        on the dotted line… what remedy does the lender

          Predatory Practices
   Some new laws in recent years have
    helped in labeling certain loans as
    ―Predatory‖, effectively attempting to
    ban them.
   High cost loans are legal, but start taking
    on illegal characteristics when the
    following occurs:
       Loan flipping (repeated refinancing)
       Balloon payments (bulk of a loan is left
        unpaid at maturity)
       Not certifying that the borrower can afford
        the payments
Due to the current events that
 occurred with Subprime
 lending, there is an
 enforcement for more strict
 standards to make certain
 negligent actions by lenders

More strict standards will
 help alleviate certain types
 of negligence and enforce
 the legal liability.
Subprime crisis draws FBI scrutiny
   NY State Attorney General Andrew Cuomo is
    about to launch an investigation.
   Numerous investigations on the federal and
    state level regarding discriminatory practices.
   FBI has recently launched an investigation,
    specifically into ―allegations of fraud in various
    stages of the mortgage process, from
    companies that bundled the loans into securities
    to the banks that ended up holding them.‖
Far Reaching –
Beyond the Banks and Brokers
   Various federal agencies have issued subpoenas to large wall street

   Among the allegations are marketing of securities backed by those
    mortgage loans, various accounting frauds and insider trading -
    backers of Subprime.

   Mortgages selling their stakes before the public became aware of
    the current problem.

           Legality Conclusion
   If acts of negligence, fraudulence, or lack of fulfilling
    contractual agreements exists by ALL parties then the
    subprime loan is illegal.
   If there are no acts of negligence, fraudulence, or
    breach of contract then the Subprime loan is legal.

Here are a few references that discusses about Sub-prime lending being illegal.
     Presented by:
Shady Business
     Michael Garcia
     Ivan Gonzalez
   Douglas Goroway
       Spiro Mellis
 Maria Lita A. Sarmiento

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