Module 7 Case Analysis

By:

Joseph Grant

BUS 421 GS

Mentor:

Prof. William Reed

The Housing Bubble

The housing bubble crisis that consumed the United States economic stability with turmoil and

negative speculation was a culmination of bad practices from both lending and consuming

perspectives. The argument can be made that induced low interest rates, safe market investment

speculation, along with spurred low-income consumption attributed to the fast money, fast

growth, and demise of the housing market. Countrywide Financial Corporation was directly in

the middle of the disastrous lending practices that crushed smaller financial institutions and large

commodity insurers initiating a financial domino affect that brought the U.S. economy to its

knees.

The expansion of homeownership increased demand for both new and existing homes and forced

prices upward, creating a housing bubble that began in 1994 and peaked in 2006. In the same

year, the housing values had increased on average16% (Thompson, 2012). In addition to

opportunities to make quick profits from buying and selling houses, rapid appreciation in home

prices allowed many homeowners to refinance or take out home equity loans. The housing

bubble burst in 2007 when the U.S economy began to weaken. The sharp decline in earnings

produced by the middle class started a ripple affect which led to a massive amount of

homeowners being no longer able to afford the mortgage payments owed to their financial

lenders. At the same time housing speculators had large scale community home project

construction contracted and in the process of being built. With the hope that homes would sale

quickly to cover their cost and make a profit, banks were eager to lend on a massive scale. The

decline of buyers in the market and the added loss of revenue due to non-payment assisted the

new supply and demand ratio for the home market that led to the decline in home values.

The ethical failure relating to this problem was the relaxed underwriting standards in the growth

of the subprime market. As the mortgage brokers widened their net sales to include relaxed

documentation requirement and impaired or limited credit histories, many loans were provided

as "stated income loans”. This simply meant the borrower did not have to prove income. Also,

the below market or "teaser" rates allowed for a low monthly payments in the first few years of

the loan and then were adjusted in line with market rates thereafter (Thompson, 2012). Some real

estate investors exploited the teaser rates in order to flip the property for profit before the rates

were adjusted. With that in mind, once the housing market slowed, the excess in the subprime

mortgage market was exposed resulting in an increase in delinquencies, defaults and foreclosures

(Thompson, 2012).

Countrywide Financial Corporations Role

In the housing market boom, Countrywide Financial catapulted onto the scene, quickly becoming

one of the nation's largest mortgage lenders. To achieve its leading market position, the company

shifted away from traditional, fixed-rate mortgages toward ever riskier loan products, overseen

by increasingly slack underwriting practices. Countrywide, as a matter of course, made loans to

borrowers with poor credit and required no verification of income or assets. The numbers looked

great on paper. Countrywide's scheme to artificially inflate earnings in the short-term initially

resulted in remarkable growth. Business boomed, the lender locked in a dominant market

position, the stock price was robust and the executives couldn't count their earnings fast enough.

But when the lender was forced to record hundreds of millions of dollars in impairment charges

and increase reserves for loan losses, the full extent of the company's wrongdoing came to light.

Countrywide's stock price plummeted, losing almost 90% of its value. 

While the executives behind the scheme cashed out, the company's shareholders hemorrhaged. In

fact, the decline in market capitalization suffered by Countrywide's investors exceeded $25

billion.  Representing the lead plaintiffs in a securities class action brought in 2007; Labaton

Sucharow took the lender and its auditor head on. The need for the Firm's advocacy was urgent,

as Countrywide executives squirreled away ill-gotten gains, Labaton Sucharow's public pension

fund clients sought to protect the retirement security of thousands of individuals who committed

their careers to public service. Three years after the case was filed, Labaton Sucharow secured a

massive settlement for damaged investors, including $600 million from Countrywide and $24

million from its auditor KPMG.   

Recommendations

The case against Countrywide underscores the necessity for tougher securities laws, which

ensure an avenue of recovery for investors damaged by the pervasive fraud that has infected the

financial system. To ensure the problem of a subprime mortgage debacle does not occur again,

companies such as Countrywide Financial Corporation should stop practicing provisions of

predatory loans to homebuyers. Lending companies should have to follow established industry

underwriting standards that protect both the shareholders and the consumer. Adjustable rate

mortgages (ARMs) should no longer be authorized in the industry. Companies should practice

transparency to all the mortgage stakeholders including the buyers, shareholders and the federal

and state governments.

Who Benefits

Considering the acts of the Countrywide Financial Corporation pertaining to their engagement in

unethical business practices by maintaining a VIP program that waived points, lenders fees, and

company borrowing rules. Innocent homebuyer, shareholders, and investors are the people who

get hurt in financial situation comparable to the Countrywide Financial debacle. Those who reap

the benefits are the mortgage companies controlling officers and the speculators who understood

the financial risk of accepting the loan with an ARM attachment and who willingly passed that

financial burden on to the individuals that purchased their homes. The American people are the

major loser in this incident, because they ultimately paid the price to sure up our financial system

to stave off a more disastrous collapse that would have rivaled the great depression of the 1920’s.

Works CitedThompson, A. (2012). Crafting and Executing Strategy: The quest for competitive advantage (Vol. 18). (McGraw-Hill, Ed.) New York, NY, USA: McGraw-Hill Irwin.

Coal Coast News (2011). Countrywide Financials $335 million racial discrimination settlement, Retrieved on July 26th, 2013 from http://calcoastnews.com/2011/12/countrywide-financial%E2%80%99s-335-million-racial-discrimination-settlement/

Huffman, M. (2008). Countrywide Settles Predatory Lending Charges for $8.68 Billion. Consumer Affairs. Retrieved from: http://www.consumeraffairs.com/news04/2008/10/countrywide_settlement.html

Investopedia (2013). Definition of Housing Bubble. Retrieved from:  http://www.investopedia.com/terms/h/housing_bubble.asp#axzz2NRrhirhT

Rickards, J. (2013). Repeal of Glass-Steagall Caused the Financial Crisis. Economic Intelligence. Retrieved from:   http://www.usnews.com/opinion/blogs/economic-intelligence/2012/08/27/repeal-of-glass-steagall-caused-the-financial-crisis