Business Policy and Strategy - CASE STUDY
The financial meltdown of 2008 proved that actions in the market place do not occur in isolation. When these actions are aggregated, the consequences can be devastating. Many lessons can be gleaned but the question is whether people are able to learn from them or continue along the same course of action due to situations of financial leverage that many possess over others.
A solid understanding of the history of the mortgage industry is crucial in contextualizing the financial crisis of 2008. An analysis of the practices and scope of operations of one of the largest players in the mortgage industry, Countrywide Financial, can shed further light on the events leading up to 2008. To help achieve this, Porter’s Five Forces Model will also be used. Upon drawing a conclusion as to the causes of the financial crises, the Political, Economic, Social and Technological Impacts on the financial industry will be evaluated. Lastly, a set of recommendations will be made to companies like Bank of America to ensure long-term financial prosperity for all parties involved.
Overview of Mortgage Lending In the United States
The policies or pieces of regulation passed by government with regard to the mortgage industry can be considered as individual blocks of wood that helped slowly fuel a fire that would eventually burn uncontrollably.
Before the year 1929, loans were limited to a select number of clients and loan terms ranged between 3 to 10 years. It is also interesting to note that loan- to- value ratios were average, approximately 60%1. This means that lenders would only provide roughly 60% of the money necessary to purchase a home. The remainder would have needed to be financed by the buyer’s own savings. Due to the fact that loans were non- amortizing, only interest payments would be made monthly, while the principal amount would be due at the end of the loan term in the form of a lump sum. As a result, homeowners would have needed to take steps to ensure that they have enough money at the loan maturity date to settle their obligations. The pressure to meet these terms would have made this form of lending risky. The Great Depression further compounded this risk and many people failed to make their payments.
The US government responded by creating:
The Federal Home Loan Bank to provide short term funding to financial institutions so they could have more money to lend for home mortgages
The National Housing Act, which insured loans made by lenders in the event borrowers defaulted
The Federal Housing Administration, which compensated lenders for losses associated with defaults
The Federal National Mortgage Association to provide a secondary market for mortgages; this means that once a loan is made it can be repackaged by the bank and sold to investors
Fannie Mae which was the old Federal National Mortgage Association was now a government enterprise
Freddie Mac which combined conforming loans with Mortgage Backed Securities and sold shares to those portfolios
After the savings and loans crisis in 1970, (financial institutions were not receiving enough interest from the mortgages they held to pay savings account holders), mortgage originations and loan servicing become different functions. Institutions could now sell Mortgage Backed Securities to investors and not have to hold these loans for 25 or 30 years. As a result, more institutions sprung up making mortgage loans and then selling them to investors. In 1987, there were 7000 of these loan originators1. By 2006, there were 530001.
In an effort to expand home ownership after 1970 the government:
Created the Community Reinvestment Act to provide financing to minorities in low income areas
Created the Depository Institution Deregulation and Monetary Control Act in 1980...