Running head: THE SUB-PRIME MORTGAGE ECONOMIC CRISIS 1

The Sub-prime Mortgage Economic Crisis and its Unethical CausesThe Sub-prime Mortgage

Economic Crisis and its Unethical Causes

Garrett M. Hoy

ASU, English 302, Fall 2018

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Abstract

This paper explores three published articles that report on the details of sub-prime mortgages and

their role in the great economic recession that the United States fell under in the late 2000s. Each

article gives a unique stance on just how these mortgages lead to Tthe gGreat Recession, as well Commented [NN1]: In googling The Great
Recession, all the websites I found had it
as present differences in how this financial crisis shaped the financial services industry that we capitalized like The Great Depression.

see today. This paper will use Jenning’s (2012) research on ethics to determine the ethical

models, rationalizations, and schools of thoughts on social responsibility that were used by

different stakeholders in the incident and discuss whether or not these ethical frameworks were

used appropriately. In doing so a conclusion will be reached critiquing the ethical decisions made

by financial institutions in offering sub-prime mortgages and accepting individuals to take on

these mortgages knowing very well that there was a high risk of default among the majority.

Keywords: sub-prime mortgage, financial services, the great recession

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The Sub-prime Mortgage Economic Crisis and its Unethical CausesThe Sub-prime Mortgage

Economic Crisis and its Unethical Causes

Sub-Prime mortgages have been identified as one of the leading causes of tThe gGreat

rRecession that ruptured the economy of the United States in the late 2000s. These mortgages

included higher interest rates and were considered riskier than other mortgages because they

were offered to buyers who did not have good credit. Although they seemed like a good option

for low-credit home buyers, those who would like to buy a house but do not have good credit,

these sub-prime mortgages were a ticking time bomb when paired with the housing bubble which

inevitably blew causing the second biggest economic disaster next to the Great Depression.

Company History

There were countless companies involved in the selling of these sub-prime mortgages.

Nearly every financial institution within the industry was involved with selling some sort of sub-

prime mortgage however in this paper we will focus be focusing on those that are directly

responsible for only a few of the higher tiered companies that were truly involved in causing this

economic downfall. These two organizations were the root of sub-prime mortgages and were

involved in the creation of them long before the great recession.

The first of these companies was known as Fannie Mae. The Federal National Mortgage

Association, also known as Fannie Mae., Fannie Mae was created in 1938 in order to add for the

purpose of adding liquidity to the home mortgage market in order to reduce bank failures and

stimulate home sales. Fannie Mae did this by purchasing mortgages from banks, and insuring

mortgages, which helped lenders to lower prices of mortgages as they were no longer responsible

for covering the risk of default. This caused home ownership rates to skyrocket up to 61.9% in

1960 (Congleton, 2009, p. 290).

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The second major company involved the sub-prime mortgage incident was Freddie Mac.

The Federal Home Loan Mortgage Corporation, also known as Freddie Mac. , Freddie Mac was

established to make loan guarantees and to stimulate a market for mortgage-backed securities.

Freddie Mac stocked up on purchased mortgages then sold them as securities on the open

market. This created a new market for mortgage-backed securities, which continued to increase

the home ownership rate as it provided a new way to finance mortgages (Congleton, 2009,

p.290).

Incident Description

The sub-prime mortgage crisis did not have one definite starting point. In the early 2000s

the interest rates attached to mortgages and housing payments were very low which allowed

individuals with suffering from low credit to be able to qualify for sub-prime mortgages.

Although these mortgages had higher interest rates, they were still manageable and helped

people to buy their own houses. On top of this, the Federal Reserve decided to significantly

lower the Federal funds rate in order to create further growth. Suddenly people who could not

afford homes were getting approved for sub-prime mortgages and purchasing houses. At this

timeBy this point, a large sum of wealthy Americans also began investing into real estate,

causing who caused even more growth in market for real estate the real estate market. Housing

prices rose significantly, as did and the number of people being approved for sub-prime

mortgages, causing many to worry this indicated an impending housing bubble. rose just as much

which began to worry many that this was going to be a housing bubble. The Federal Reserve

then raised the interest rate several times in order to slow the inevitable inflation, which only

made things worse. Soon after, the housing bubble popped and shook the economy. Tthe housing

market crashed and sub-prime mortgage lenders filed for bankruptcy, shut down entirely, or at
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the very least began to lay off thousands of employees, which haltinged the once seemingly

booming American economy (Fiorillo, 2018). In regards to households, the decline of house

prices weakened household balance sheets and quickly decreased consumer spending on all

commodities. The buckle of the asset-backed financial services market eventually carried over to

the real sector of the economy, causing sharp decreases in residential investment, automobile

demand, and many other types of spending that were reliant crutched on lending (Gertler &

Gilchrist, 2018, p.13). This however was not the end. As the financial condition within the

United States began to deteriorate, the Federal Reserve quickly reversed short-term interest rates

to stop the seizure., Hhowever, because of how drastic of a financial event this wasdue to the

drastic nature of this financial event, all short-term interest rates were eventually reduced to zero.

The Federal Reserve’s traditional tool could no longer help and the lower bound on the nominal

interest rate reaching zero began to constrain many other major central banks such as the

European Central Bank and the Bank of England. This presented the problem of the financial

recession inside other countries external to the United States (Gertler & Gilchrist, 2018, p.9)

Ethics Discussion
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References

Congleton, R. D. (2009). On the political economy of the financial crisis and bailout of 2008–

2009. Public Choice,140(3-4), 287-317. doi:10.1007/s11127-009-9478-z

Fiorillo, Steve. “What Was the Subprime Mortgage Crisis and How Did It Happen?” TheStreet,

TheStreet, 7 Sept. 2018, www.thestreet.com/personal-finance/mortgages/subprime-mortgage-

crisis-14704400.

Gertler, M., & Gilchrist, S. (2018). What Happened: Financial Factors in the Great Recession. The

Journal of Economic Perspectives,32(3), 3-30. doi:10.3386/w24746

Jennings, M. M. (2012). Business ethics: Case studies and selected readings. Mason, OH: South-

Western Cengage Learning.