Ethics Case: Subprime

Teaching Finance Ethics Using the Case of the Subprime Mortgage Meltdown

David S. Steingard, Saint Joseph’s University George Webster, Saint Joseph’s University ABSTRACT The authors present the subprime mortgage crisis as a case for teaching business ethics in finance, arguing that the crisis lends itself to rich, focused moral analyses of accountability, responsibility, and reparations. Following a description of the flow of the subprime mortgage process, the authors offer detailed financial and ethical analyses of the specific transactions between stakeholders at three levels, the primary market level, the subprime loan (i.e., instrument) level, and the secondary market level. Broader implications for teaching ethics in finance are also discussed. INTRODUCTION One of the most important developments in the world of finance over the last century has been the collapse of the subprime mortgage market. This includes the closing of thousands of subprime lenders, the rapid rise in mortgage defaults, the severe downturn in the housing and construction industries, the staggering losses that have been taken by financial service firms, and the negative effect this problem has had on the economy at large. We already have seen two hedge funds collapse, emergency Federal Reserve-backed buyout of Bear Stearns, the collapse of IndyMac, a large California savings bank, and Fed’s astonishing takeover of both Fannie Mae and Freddie Mac (the two largest institutions in the secondary mortgage market). The subprime mortgage story is replete with insights about economics and finance, as well as about business ethics and the moral evaluation of market mechanisms.i The subprime story, from a pedagogical point of view, is compelling on two fronts. First, the subprime story allows finance professors to explicate the complex interrelationships between stakeholders and financial instruments in a variety of markets. Second, considerable negative impacts from the case allow for focused moral...