Ethical Finance: An Oxymoron?
by ad.nauseam on February 10, 2015 - 5:20pm
Just the words “money manager” or “investment bank” bring to mind images of liars, cheaters, and connivers. Perhaps the greatest depiction of this utter lack of morality came in the winter of 2007, when the Great Recession began. This marked the beginning of the most severe global economic meltdown since the Depression. While the causes of the 2008 financial crisis are exceedingly complex, one of the key contributors was subprime lending. Without delving into the specifics of the crash, it came down to banks providing loans to individuals with poor credit (Denning). In the following, I would like to attempt the impossible and merge the study of ethics with finance by analyzing the principle of subprime lending.
Before establishing an ethical framework, I would like to define the dilemma as I see it. For the sake of simplicity, I will only consider two parties – the lender and the borrower. The borrower has few assets and conceivably has a history of late payments or defaults, and as such, is considered to be at risk of future delinquency. The lender, on the other hand, can charge a far higher interest rate because of the additional risk they take on (Appelbaum). To simplify the discussion, I will assume that the lender takes on all the risk (which was not the case, in reality). As such, there are a variety of ethical questions. Do these borrowers deserve financing? Should these lenders attempt to profit off desperate individuals? I will analyze these moral dilemmas by applying the teleological framework.
Teleological ethical theory focuses on outcomes. Therefore, from the teleological standpoint, an action is only deemed right or wrong based on the consequences it brings (Merrill, p. 35). More specifically, utilitarian ethics is a teleological subtheory that abides by the Greatest Happiness Principle. This means that an action is ethical if it brings the greatest happiness for the greatest number of individuals (Merrill, p. 35). Using this school of thought, it would appear that subprime lending is ethical. The lender makes a handsome profit and the borrower can live happily ever after in a McMansion they otherwise wouldn’t have been able to afford.
In the case of a default, however, the ethical landscape shifts. Suddenly, a subprime borrower is plunged further into debt and the lender is forced to foreclose the property at a loss. And here we’ve arrived at one of the fundamental problems with utilitarianism: the inability to accurately predict outcomes. While it is incredibly uncomfortable for a utilitarian to consider intentions, it is imperative to fully analyze this problem (Merrill, p. 35). If the lender wants to make a quick buck from a desperate situation and the borrower wants to temporarily live lavishly, then both their intentions are not to optimize happiness for the greatest number of people. This is therefore unethical. On the contrary, if the lender and the borrower enter a mutually beneficial agreement to get the borrower out of poverty, then this is an ethical act. Interestingly, I believe that when the incentives of the borrower and the lender are aligned, the likelihood of a default is actually diminished.
In the final analysis, I believe the ethical burden falls on the lender. While the borrower can repeatedly request loans, the lenders must carefully select their clients and develop a vested interest in the success of their clients. I therefore believe that subprime lending should become a mechanism for social mobility and not a playground for profiteering. The only way to ascertain that this happens is through regulation. While in the past, subprime lenders have been able avoid risk through financial instruments, they need to take on complete accountability. In this manner, they are incentivized to lend responsibly.
Appelbaum, Binyamin. “Are Subprime Mortgages Coming Back.” The New York Times. n.p., n.d., 9 Sept. 2014. Web. 9 Feb. 2015.
Denning, Steve. “Lest We Forget: Why We Had A Financial Crisis.” Forbes. n.p., n.d., 22 Nov. 2011. Web. 9 Feb. 2015.
Merrill, C. John. "Overview: Theoretical Foundations for Media Ethic," in Gordon, A. David, Kittross, John M, Merril, John C, Babcock, William and Dorsehr, Michael (eds.), Controversies in Media Ethics, 3nd Edition. (New York: Routledge, 2011)