In some ways, subprime mortgage lending can be good.
Subprime mortgage loans allow many people the opportunity to own a home who would have otherwise been unable. Subprime mortgage loans were partially supported by some early attempts by the government to encourage banks to lend to lower or middle-income families so they would have equal access to affordable housing (Demyanyk & Van Hemert, 2011).
However, the vast majority of subprime loans were not given for home purchases. In 2005, 84 percent of subprime mortgage loans were issued to refinance existing mortgages or as a second mortgage, not for a home purchase (Gilbert, 2011).
Banks understandably tend to shy away from behaviors that could cost them profit. Though, they found after the crisis that by not practicing some level of social responsibility, shareholders are less likely to do business with them (Peavler, 2016).
Many banks saw subprime loans as an opportunity to make a quick profit, without regard to the cost it may have on debtors (Peavler, 2016; Watkins, 2011). They were able to use a social responsibility concept – ensuring everyone had the opportunity to own a home, in order to turn a profit. It is the very essence of what social responsibility for businesses is supposed to be about – making money while giving the community what it thinks it wants.
Except, it wasn’t what the community needed. Everyone involved should have known that. After seeing the impacts of the last subprime mortgage crisis, one should be able to clearly see how it would be in the best interest of society to ensure a situation like that is not repeated.
Some measures have been proposed to help avoid another financial crisis – like the one that occurred as result of the subprime mortgage crisis, though very few have passed or been implemented.
The primary piece of legislation to pass, though with room to change, was the Dodd-Frank Wall Street Reform and Consumer Protection Act, also known as the Dodd-Frank. One purpose of this act was to put controls in place to keep any one institution from becoming too important by requiring additional regulation and the risk of being broken up if the newly created Financial Stability Oversight Council determined a financial institution was getting too big (Koba, 2012).
The Dodd-Frank also forbids banks from having or investing in any proprietary trading funds or operations for the banks’ profits (as opposed to those for customers) but does allow for some trading as required to successfully run the bank (Koba, 2012). However, this rule has not yet been implemented, with the U.S. Federal Reserve again extending the deadline for banks to become compliant until summer of 2017 (McKenna, 2016).
Here is a “cheat sheet” to understanding the Dodd-Frank.
Of course, things do not always work out as planned.
The best way to make sure a situation like this does not happen again is to ensure society (as a whole) keeps responsible lending and borrowing practices. As long as banks will lend to high-risk borrowers, some people will borrow. But it is important for the borrowers to understand their limits and borrow only what they can comfortably afford. Perhaps if there were stronger penalties for defaulting on a loan, borrowers would be less likely to borrow more than they could truly afford to pay back.
That would really show social responsibility.
Demyanyk, Y., & Van Hemert, O. (2011). Understanding the subprime mortgage crisis. Review of Financial Studies, 24(6), 1848-1880. http://dx.doi.org/10.1093/rfs/hhp033
Gilbert, J. (2011). Moral duties in business and their societal impacts: The case of the subprime lending mess. Business & Society Review, 116(1), 87-107. http://dx.doi.org/10.1111/j.1467-8594.2011.00378.x
Koba, M. (2012). Dodd-Frank Act: CNBC explains. Retrieved March 22, 2017, from http://www.cnbc.com/id/47075854
McKenna, F. (2016). Fed extends deadline again for Volcker Rule implementation. Retrieved March 22, 2017, from http://www.marketwatch.com/story/fed-extends-deadline-again-for-volcker-rule-implementation-2016-07-07
Peavler, R. (2016). How do we prevent another financial crisis? Retrieved March 22, 2017, from https://www.thebalance.com/how-do-we-prevent-another-financial-crisis-393151
Watkins, J. P. (2011). Banking Ethics and the Goldman Rule. Journal of Economic Issues, XLV(2), 363-371. http://dx.doi.org/10.2753/JEI0021-3624450213