According to news article on September 2nd contributed by Rexrode (2011) from AP, “The government on Friday sued 17 financial firms, including the largest U.S. banks, for selling Fannie Mae and Freddie Mac (Appendix) billions of dollars worth of mortgage-backed securities that turned toxic when the housing market collapsed”. Beyond the apparent legal issues, this article intrigued me to examine whether or not there are ethical issues involved regarding banks selling mortgage-backed securities. A mortgage-backed security is defined by Securities and Exchange Commission (SEC 2010) as debt obligations that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property. To put it simple, the buyers/investors of such securities are the lenders to all the homebuyers in the Unites States who pay mortgages.
The reason why US government sues major banks seems rational at first glance: Subprime mortgage crisis caused millions of people lost their jobs; after all, someone must take the blame, right? But after second thought, we may wonder, are banks really the ones that caused subprime mortgage crisis by selling mortgage-backed securities? Should banks be blamed for the hefty loss of investors that involved in subprime mortgage? Is it justified for the government to sue those banks now, instead of stopping the issue of risky securities before? To be specific, the purpose of this essay is to identify if major banks are ethical for selling mortgage-backed securities.
Housing Market vs. Major Banks
Should banks be blamed by selling mortgage backed securities? They shouldn’t be blamed for it, because the dramatic price drop of mortgage backed securities was not the ultimate reason that led to the collapsed of house price, and not the ultimate reason cost investors who involved in mortgage backed securities billions of dollars.
After reaching its peak in 2006, the US housing market finally collapsed, since then average house price have drop more than 30% as of 2010. (Parsons, 2011) What caused the housing price collapsed, that ultimately led to the downward of US Economy, was that many mortgages were paid by adjustable-rate (Appendix), which increases in accordance with house price. Since the house price were picked up in an ascending speed from 2000 to 2006, so was the interest rate homeowners had to pay every month. Eventually, the interest went extremely high in 2006 and homeowners could not afford to pay their monthly mortgages anymore, and lost their home to the banks. That caused the chain reactions resulting in the dramatic price drop of mortgage backed securities because of diminishing house price. Dramatic security price drop could not have caused the house price dropped; on the contrary, had only the dramatic house price drop led to the securities price drop that ultimately cost investors billions of dollars. As a matter of fact, major banks and financial firms were only...