Countrywide Financial Corporation was a mortgage lending giant founded by Angelo Mozilo and David Loeb in 1969. By 1980, the company had 40 offices in 8 states and was on its way to achieving Mozilo and Loeb’s goal of becoming a nationwide mortgage lending firm. The following year, the pair launched a securities subsidiary that specialized in the sale of mortgage-backed securities (MBSs). Riding the wave of the U. S. housing market bubble, the company was at the height of its success between 1994 and 2006. By 2006, the company originated more than 2. million loans totaling $408 billion.
However, the collapse of the housing market in 2007 drastically changed the future of Countrywide Financial. While the company had a market value of $24 billion in 2006, the value fell rapidly when it became evident that many of the mortgages Countrywide had made during the housing boom were overly risky and likely to go into default. In 2008, the company was acquired by Bank of America for $4 billion in stock. Shortly after the acquisition, Bank of America’s management entered into an $8. billion settlement with a group of state attorney general over Countrywide’s predatory lending practices. Mozilo, who collected a severance package valued between $80 million and $115 million following the acquisition, and two other executives were indicted by the SEC for fraudulent misrepresentation of the risk inherent in the company’s loan portfolio. Many issues related to Countrywide’s business practices and lack of ethics resulted in the company’s failure as well as the subprime mortgage market collapse as a whole.
Analysis Countrywide made significant changes to its business strategy as the housing market changed between 1994 and 2008. It went from providing mainly prime mortgages backed with high underwriting standards to a relaxed environment of little documentation and risky business practices. The main issue for Countrywide was this dramatic change in strategy that did not encourage adequate evaluation of the risk associated with its business practices and turned a blind eye to unethical business behavior. Risky or unethical usiness practices engaged in by Countrywide Financial Corporation include the following: * Relaxed underwriting standards that did not require customers to verify income or go through a full credit history check. This allowed customers to be approved for a loan they could not realistically afford or have loans on multiple homes at one time that they could not adequately cover. * Adjustable rate mortgages (ARMs) that increased after the initial low interest rate period allowed customers to purchase homes they could initial afford.
Many customers planned on flipping the home or counted on the home value increasing enough that they could sell the home before the rate increased to a point they could no longer afford. * Increase in home values during the housing bubble allowed customers instant equity in their homes to borrow against which was financed by companies like Countrywide. Countrywide did not properly assess the risk associated with this type of loan. * In 2004 Countrywide greatly increased the amount of subprime loans and no-down-payment loans.
Customers could purchase a home with no down payment and also receive a home equity loan for 20% of the home’s value. This resulted in inadequate collateral for these types of loans that were dependent on the value of the home to increase. Once the housing bubble burst, these properties were worth considerably less than their value at the time of purchase. If the customer defaulted or went into foreclosure on the property, there was a considerable loss on from the original amount of the loan. * These loans were then sold into the secondary mortgage market as mortgage backed securities.
The risk associated with the MBSs (default, foreclosures, and downgrades of the high risk) was masked by the rise in real estate values through 2006. Countrywide did not fully disclose the risk associated with these MBS that were then sold to investors on Wall Street. * Mortgage originators were paid commissions on the loans but approving customers that then defaulted on a loan was not a metric included in the compensation package. This motivated the originators to approve customers without considering the risk associated with the loan.
Compensation was tied to volume of loans written and not on the quality of the loans. * Countrywide Financial used predatory loan practices. This included not fully disclosing the terms and conditions of loans, putting customers into an inappropriate loan that they could not afford, and not fully disclosing how the ARM loans worked. Evaluation Countrywide was seen as a mortgage lender that generally backed prime mortgages that were underwritten with high standards and sold stable loans as mortgage backed securities. As described in the Analysis, however, this was not the case.
Countrywide’s collapse demonstrates the need for business ethics and corporate social responsibility. Many of Countrywide’s actions were illegal but many of the practices were simply unethical. The company exhibited all three drivers of unethical business behavior described in our text: 1. Faulty oversight by top management and the board of directors that implicitly allows the overzealous pursuit of personal gain, wealth, and other self-interests. This was certainly the case at Countrywide. Employees were compensated with commissions as incentives as over half their pay from 2001-2007.
As discussed previously, commissions were based on mortgage volume and numbers generated, not on loan quality or risk rating. This type of compensation plan encouraged unethical business practices and resulted in personal gain for employees that embraced this business practice. Mozilo also rewarded himself with extremely high annual incentives and equity awards. 2. Heavy pressures on company managers to meet or beat performance targets. Although this was not exclusively mentioned in the case study, Countrywide was probably participating in this type of practice as well.
There were large increases in mortgage loan production numbers during the housing bubble that Countrywide probably tied to increase quarter after quarter. It sold the MBS to Wall Street without disclosing the true risk associated with its subprime loans. This downplayed any risk associated with the MBS to analysts, investors, and other creditors and contributed to the banking industry collapse and stock market decline. It can be seen through Countrywide’s increasingly relaxed standards that no one was considering the true risk associated with its business practices. . A company culture that puts profitability and good business performance ahead of ethical behavior. This also occurred at Countrywide. The customer was not put at the top of the list for the company’s focus. Customers were encouraged to enter into mortgages they could not afford or not matched with the best products for their needs. Worst yet, the terms, conditions, and rates of ARMs and home equity lines of credit were not fully disclosed. The company was putting its own profitability ahead of ethical behavior.
At the heart of Countrywide Financial’s issues were unethical business practices, unacknowledged business risk, and unbalanced corporate social responsibilities. After Bank of America acquired Countrywide Financial, it was left to pick up the pieces and deal with Countrywide’s business ethics failures. These were in the form of government penalties, civil litigation, employee issues, and a damaged company image and reputation. Recommendations It is recommended that Bank of America take swift and immediate action to instill a higher regard for ethics in its business practices and the company culture of its new acquisition, Countrywide.
Employees at all levels should be given ethics training in order understand the ways in which unscrupulous behavior hurts the company in the long term. Additionally, the company should continue to work with borrowers who were victims of Countrywide’s predatory lending practices and discontinue negative amortization loan programs that allowed borrowers pay options whose monthly payments were less than the interest due. Lenders must work to ensure that borrowers fully understand the terms and risks of their loans.
Similarly, down payments and interest rates must be appropriate for the borrowers’ proven income and credit history. Bank of America should work to ensure that lending practices strike a balance between the economic responsibility to reward shareholders with profits, the legal responsibility to comply with the laws of the countries where it operates, the ethical responsibility to abide by society’s norms of what is moral and just, and the discretionary philanthropic responsibility to contribute to the noneconomic needs of society.
As part of that balance, the company must work to ensure that mortgages meet federal requirements intended to promote homeownership among previously disadvantaged socio-economic groups while preventing prospective homeowners from borrowing more than they can afford. Case Update In June 2010, two Countrywide mortgage servicing companies agreed to pay $108 million to settle Federal Trade Commission charges that they collected excessive fees from borrowers.
The amount is one of the largest judgments imposed in an FTC case and will be used to reimburse overcharged homeowners whose loans were serviced by Countrywide before the Bank of America acquisition. In October of the same year, Mozilo agreed to pay $67. 5 million to the SEC to settle fraud charges and avoid a trial that could have resulted in additional criminal and insider-trading charges. The penalty included forfeiture of $45 million in “ill-gotten gains” and a $22. million fine – the largest penalty ever on a senior executive of a public company. However, “$25 million of Mozilo’s restitution will come from an escrow fund the company set up to cover shareholder litigation, and Mozilo has no obligation to pay the remaining amount, according to the settlement agreement. ” The House Oversight and Government Reform Committee has been investigating the VIP “Friends of Angelo” loan program and, just last month, announced the intention of interviewing Mozilo.
To date, Bank of America has suffered tens of billions of dollars in losses as a result of buying Countrywide. Several investors including Fannie Mae are demanding that the bank repurchase “toxic” mortgage securities sold by Countrywide. However, Bank of America has balked at Fannie Mae’s unprecedented demands and, less than a month ago, announced that it would no longer provide new mortgages to Fannie Mae but pledged to continue to help borrowers refinance or modify mortgages backed by Fannie Mae.