Ethics Newsline®

NEW YORK
Fallout from convulsions in the subprime lending market continued last week as the value of some funds specializing in loans to borrowers with poor credit plummeted.

BusinessWeek reports that investors fled from subprime funds after a report issued last week concluded that two such financial vehicles offered by the Bear Stearns brokerage were now essentially worthless.

According to the Financial Times, confidence further eroded late last week after Federal Reserve chairman Ben Bernanke commented on credit problems related to subprime lending during testimony before Congress.

Bernanke told lawmakers that “rising delinquencies and foreclosures are creating personal, economic, and social distress for many homeowners and communities, problems that likely will get worse before they get better,” according to a report from the Australian Broadcasting Corporation.

Bernanke charged that the expansion of the subprime market was “clearly accompanied by deterioration in underwriting standards and, in some cases, by abusive lending practices and outright fraud.”

“In addition, some households took on mortgage obligations they could not meet, perhaps in some cases because they did not fully understand the terms,” he said.

Subprime lending became a profitable niche in recent years because lenders focused on customers with poor credit, offering loans at high interest rates on the theory that customers who couldn’t pay back the loans could simply refinance because housing prices would continue to climb. But an unexpected slowdown in the housing market resulted in a rising tide of slow-payers, no-payers, defaults, and repossessions.

In an opinion piece titled “Shaky Ethics of Subprime Lending Lead to Shaken Investors,” MarketWatch columnist Thomas Kostigen contends that “it should come as no surprise that investors in the subprime mortgage business are experiencing big losses. Investing in any business built on shaky ethical grounds is risky business in and of itself. And the subprime mortgage business is indeed built on shaky ethical grounds.”

Kostigen writes: “Several investment research firms have produced studies that show investing in ethically managed companies produces better and more stable profits over a long period of time. The studies point to a very simple business model: managers who seek to do good engender operations and morale that are positive. Positive means growth. That type of growth usually means more profits based on solid fundamentals — not flash-in-the pan schemes.”