Part III-Examining the Financial and Ethical Issues Surrounding Subprime Loans by Slemo Warigon

Part III – Subprime Loans, Social Responsibility, and Resultant Changes

Social Responsibility and Consequences of Unethical Actions

The definitions of social responsibility abound with no clear consensus regarding the exact meaning of the term (Kolk, 2016). To some, social responsibility means socially responsible behavior in an ethical sense, and others view it as a fiduciary duty imposing higher standards of behavior on the businesses than on citizens at large (Kolk, 2016).  These definitions are synonymous with the definitions of corporate social responsibility (CSR), which asserts that the social responsibility of business is an important part of its social contract consisting of generally accepted relationships, and moral obligations or duties that relate to the corporate impact on the welfare of society (Robin & Reidenbach, 1987; Gilbert, 2011). The ethical element of CSR requires firms to take actions that are legitimate, just, fair, and not harmful (Quarshie et al., 2016). Similarly, CSR consists of activities that advance a social cause beyond regulatory compliance and that focus more on managing a business entity in such a way that it can be economically profitable, law abiding, ethical, and socially responsible (Kolk, 2016; Seto-Pamies & Papaoikonomou, 2016; Christensen et al., 2014). These definitions explain why some authors use CSR and business ethics interchangeably (Rodriguez-Fernandez, 2016; Seto-Pamies & Papaoikonomou, 2016; Sroka & Lorinczy, 2015).

CSR research increasingly focuses on the social, legal, ethical, economic, environmental, and philanthropic obligations of business (Kolk, 2016; Rodriguez-Fernandez, 2016; Quarshie et al., 2016). Specifically, in recent decades, circumstances such as the: 1) increasing number of corporate fiscal abuses and opportunistic strategies in the financial markets; 2) increase of social inequities reflected in poverty, hunger, or discrimination among countries; 3) the great power held by multinational corporations; and 4) the environmental degradation caused the affected parties (e.g., shareholders, employees, customers, citizens, local community, government, and other stakeholders) to require a greater commitment and responsibility from corporate activities (Martinez et al., 2016; Kolk, 2016). All these make the operating environment both complex and turbulent, necessitating firms to develop competitive management models for obtaining profit margins in the short-term and meeting the balanced expectations of society and the different stakeholders involved in its activities in the long term (Martinez et al., 2016).  In response, an increasing majority of corporations in global economy have adopted CSR as a key tool that helps them to proactively address these environmental pressures and social challenges (Wang, Tong, Riki, & Gerard, 2016; Martinez et al., 2016). In fact, over 800 companies from more than 150 countries are signatories to the United Nations’ Global Compact, covering issues on human rights, labor standards, the environment, and anti-corruption initiatives (Wang et al., 2016).

In short, CSR is essentially about acknowledging accountability for the impact of individual and organizational choices on the larger world.  Rather than focusing exclusively on profit margins, firms are expected to make the welfare of society a priority when making corporate decisions.  It should be noted that socially responsible behaviors differ by societies, cultures, and subcultures (Robin & Reidenbach, 1987).  This explains why a socially responsible behavior by one stakeholder group has the potential to generate a complaint by another group. Also, CSR is viewed as a political process in which the meaning of corporate action is contested through discursive interaction between firms and their stakeholders (Skilton & Purdy, 2017). Similarly, traits, values, attitudes, and motivations of leaders influence either socially responsible or irresponsible behaviors in organizations (Christensen et al., 2014). For instance, leaders motivated by instrumental view tend to take CSR actions that help maximize profits for their firms, while leaders motivated by altruistic CSR promote corporate culture and behaviors that achieve greater social good (Christensen et al., 2014).

The subprime mortgage loan lenders employed the instrumental CSR activities primarily to maximize corporate profits, and secondarily to offer high-risk loans to low-income borrowers. Those leaders were following the Goldman Sachs’ rule by refusing to engage in socially responsible actions that lowered their opportunities to maximize corporate profits (Watkins, 2011). Milton Friedman expressed the following views that were diametrically opposed to the CSR concept (Friedman, 1970):

  • Businessmen who believe they are defending free enterprise when they declare that their firms are not concerned with only profits, but also with promoting desirable social ends by taking seriously their responsibilities for providing employment, eliminating discrimination, and avoiding pollution are actually preaching socialism and serving as the unwitting puppets of the intellectual forces working to undermine the basis of a free society.
  • Individuals, not and corporations or business, have responsibilities. Corporations are artificial persons with possibly artificial responsibilities. Thus, the CSR remains largely unclear.
  • In a free-enterprise system, a corporate leader is an employee of the business owners. He is directly and primarily responsible to his employers. This responsibility entails conducting the business in accordance with the employers’ desires, which generally are to make as much money as possible while conforming to the basic rules of the society as reflected in law and ethical custom.
  • The corporate leader is also a person in his own right. He may personally have many other responsibilities to his conscience, family, charity, church, clubs, city, or country that he voluntarily assumes. These responsibilities may compel him to devote part of his income to causes he deems worthy, refuse to work for particular businesses, leave his current job, or join his country’s armed forces. All in all, he is acting as a principal, not an agent of the business owners; spending his own money, time, and energy, not his employers’ money. These are social responsibilities of individuals, not business.
  • Asserting that the corporate leader has a social responsibility in his capacity as businessman is akin to asking the leader to act in ways that is not in the best interest of his employees.

In summary, Friedman (1970) believed that social responsibility for business requires the corporate leader to spend someone else’s money for general social interests, such as reducing returns to stockholders, raising prices to spend customers’ money, and lowering wages to spend employees’ money. All these accept the socialist view that political mechanisms, not free market mechanisms, are the appropriate way to determine the allocation of scare resources to alternative uses (Friedman, 1970).  In a free society, the only “social responsibility” of a business is to use its resources to engage in activities designed to increase its profits in compliance with legal and regulatory requirements (Friedman, 1970).

Pursuing CSR actions help firms to achieve sustainable profits from socially responsible financial investments, obtain competitive advantage, and improve relationships with key stakeholders by promoting social good (Gilbert, 2011; Paulet et al., 2015; Kolk, 2016; Rodriguez-Fernandez, 2016; Quarshie et al., 2016). Conversely, firms not pursuing CSR activities incur significant costs from bad publicity, lost customer loyalty, and penalties for noncompliance with regulatory requirements that would adversely impact corporate profits (Rodriguez-Fernandez, 2016; Sroka & Lorinczy, 2015; Watkins, 2011). Banks involved in unethical subprime mortgage loans failed to retain thousands of their talented employees, wrote off hundreds of billions of dollars on their subprime loan assets; caused financial instruments tied to securitized subprime mortgages to significantly lose value, removed borrowers from their homes due to foreclosures, and many other problems with social and economic impacts (Gilbert, 2011; Watkins, 2011; Agarwal et al., 2014; Mayer et al., 2014; Cao& Liu, 2016).

Eventually, the U.S. federal government bailed those failed banks (Watkins, 2011) without holding their leaders and managers responsible for their unethical behaviors (Mayer at al., 2014). Senior federal government leaders sent confusing messages in the aftermath of the financial crisis and resultant government bailouts, with some stating that most of those socially irresponsible lenders did was recklessly unethical rather than illegal, but others stated that the lenders committed illegal acts (Mayer et al., 2014).

Reforms After the Subprime Mortgage Crisis

Some authors argued that not prosecuting individuals responsible for the subprime mortgage crisis was due to regulatory lapses and deregulation of banking oversight by the federal government, and that this lack of accountability will not prevent people running the banks from committing the same unethical acts that caused the crisis (Mayer et al., 2014). Others argued that the government bailouts did not change the economic or business model used by conventional banks that caused the crisis (Paulet et al., 2015; Watkins, 2011).

States like Illinois passed a legislation in 2005 to curb predatory and reckless lending practices with new enforcement mechanism, tougher penalties for noncompliance, and mandatory credit counseling for borrowers with minimum credit score of 620 (Agarwal et al., 2014). The Basel III global regulatory framework introduced new regulations to improve the accountability, transparency, risk management, corporate governance, and resiliency of the banking institutions (BIS, 2011; Watkins, 2011; Paulet et al., 2015). The Basel III framework has its shortcomings, namely banks are expected to comply with the new regulations in 2019, the pre-crisis banking structure remains unchanged, social purpose of banking activities is not clearly defined, and the problem associated with certain financial firms that are too big to fail was not resolved to prevent future financial crises (Watkins, 2011; Paulet et al., 2015). However, some banks have changed their banking practices to comply with Basel III’s new regulations, and embed socially responsible behavior in their corporate culture (Paulet et al., 2015).

Conclusion

The unethical banking practices, including the predatory and reckless lending decisions, caused the subprime mortgage crisis that adversely impacted all stakeholders. These ethical incidents significantly decreased public trust in both the banking institutions and regulatory environment controlled by the government. Stakeholders or members of society legitimately expect professional lenders to act in a manner consistent with legal, ethical, social, and professional requirements in order to earn and retain public trust. Executive leaders who consistently serve as accountable and ethical role models help promote ethical behavior throughout their firms, thereby helping to prevent recurrence of a disastrous financial crisis.


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