Wells Fargo Subprime Crisis Management - Case Study Example

Wells Fargo Subprime Crisis Management Introduction Subprime lending refers to the lending of money by banks to people with low credit scores. Banks choose to lend money to these kinds of customers for a number of important reasons. First, most banks can look at the subprime lending as a strategy to acquire more market. This is because the subprime market is overlooked due to the fact that most banks may not be willing to lend money to these people (Darbellay, 2013). Additionally, the banking institutions may want to access this market because of the high returns of the loans. Subprime loans and mortgages are always given out at much higher interest rates and this can help the banks to earn more per unit of money lent out. However, as Gramlich (2007) says, this depends on the rate of default, which is usually higher than that of prime lending due to the low credit rating of the target market. In the case of mortgages, the banks may even earn more by foreclosing the home of the defaulting customers and then re-selling the home. This helps the bank to make even more money, albeit unethically. Subprime lending is also considered as a way to help families who would in any other case may not be able to access financing, regardless of their low credit score (Tighe & Mueller, 2013). In the United States, the use of subprime lending increased from about the 1990s. By mid of 2000s, the mortgage sector in the United States was dishing out billions in the form of subprime mortgages to people with very low credit ratings. Eventually, a mortgage bubble developed and ended up busting in 2008, and thus creating a financial liquidity crisis. The subprime crisis in the United States affected not only the mortgage owners and banks, but also investors who had invested in securities which were backed with the subprime mortgages (Valdez & Molyneux, 2010). A need to deal with the ensuing subprime crisis was imminent and this came from many quarters. The first was the government with the introduction of new regulations and laws to regulate the mortgage and the financial sector. Dodd-Frank law The Dodd–Frank Act was an Act that was signed by President Barrack Obama in 2010 and was geared towards regulating the financial services industry. The Bill came in the trail of the subprime lending crisis which in most part is seen as the main cause for the credit crunch and the 2008 financial crisis. The bill tried to create some rules which would be useful in regulating the financial services market as well as the mortgage market. Section 14 of the same law includes a number of provisions which are geared towards customer protection. In section A of the Dodd–Frank Wall Street Reform and Consumer Protection Act, mortgage originators are supposed to ensure that they only give loans and mortgages to customers who are highly likely to pay. This is in order to counter the issue of massive defaults and the negative results that this has, not only on the consumers of these mortgages, but also to the economy as well as the investors (Engel & McCoy, 2011). Effectiveness of the Dodd–Frank Wall Street Reform and Consumer Protection Act The effectiveness of the Dodd–Frank Act can be disputed due to a number of reasons. First, there is the issue of the law not being precise with its provisions. Most of the articles in the law only use generic or immeasurable tools to deal with the issue of subprime mortgage lending. For instance, the law points that the mortgage originators are supposed to only give loans to people who have a higher likelihood to be able to repay. However, how the differentiation between those who are highly likely to pay and those who are not is done is a matter of controversy. Additionally, even after the law came into force, there are still banks which are still engaging the subprime market and in this case not able to look at the ways the things are supposed to be done. The best example is Wells Fargo bank that even before it has been able to clear its name with regard to the many issues it is having regarding the subprime market, has been seen to start going back to the subprime market. Many banks have followed suit and are going back to this low end market, giving mortgages, albeit in other titles for thee mortgage as opposed to calling them subprime. For instance, other banks are offering the same subprime loans and mortgages but instead of giving the loans the terms subprime, they are calling them better, more appealing names such as alternative financing. This then leaves the question how well the Dodd–Frank Act is with regard to solving the subprime issue and whether it has provided for permanent solutions. The second place where the attempt to solve the subprime crisis is coming from was the banks and other participants of the mortgage industry. Wells Fargo was one of the mortgage providers that had received the most negative impact from the subprime crisis. This is because apart from losing a lot of investments, the bank was also faced with law suits from both government and from individuals and firms. A history of the Wells Fargo banks Wells Fargo is a bank-holding company with many institutions under it. The firm offers many financial services including mortgage, financial advisory services and investment banking. Wells Fargo is the biggest bank-holding firm in the United States. Due to its being the biggest mortgage originator and the fact that the firm also depended a lot on subprime loans to boost its revenue, the bank was hit the most by the subprime lending crisis. As a result, it has had many issues including law suits, the most current one being from the attorney general of New York State. The suit that faces Wells Fargo is geared towards making sure that the firm complies with the national mortgage settlement which was an agreement signed buy 49 states in the United States. The attorney general of New York wanted to make sure that the bank is addressing the issues raised in the National Mortgage Settlement and that the bank is committed to making the right changes. The great purchase One of the strategies that Wells Fargo used to deal with the subprime mortgage products was to acquire a major banking institution. The institution was the Wachovia which was also a bank-holding company. Wachovia was the fourth largest bank-holding company in the country until it was acquired by Wells Fargo in 2008. By acquiring Wachovia, Wells Fargo was hoping to expand its market reach and at the same time increase customer base. The Wachovia acquisitions comes in with much controversy because even as this will help in increasing the reach for the bank especially in north of USA, the acquisition has come with lots of financial obligations because Wachovia was also having its own liquidity issues. It cannot be clear that this acquisition will be of any help to the firm which is definitely already having issues with its revenue generation. Wells Fargo, by the time of acquiring Wachovia, was already facing much litigation against it due to some issues with the standards of its mortgage origination. Wells Fargo for instance, was already in a litigation suit with Fannie Mae who was suing Well Fargo for originating sub standard mortgages. The litigation ended with Well Fargo settling the issue with a settlement of over $591 million with the Fannie Mae. The settlement with Fannie Mae The 591 million settlements with the Federal National Mortgage Association was one of Well Fargo’s attempts at clearing its name on the issue of subprime mortgage servicing. The attempt can be seen as a public relations act. The payment was reached after a year of legal processes and Well Fargo eventually paid. However, despite the fact that this can be seen as a due process of law taking place, it is also seen as public relations act because big firms like Wells Fargo have the capital that can be used to expand such a legal process for years or even decades. Choosing to have the settlement can be seen as a public relations strategy by Wells Fargo bank to clear its name with regard to the stain of subprime lending. As already noted, Wells Fargo had a very big stake on the developing of the subprime lending crisis due to its huge control of that sector. The settlement was seen as a preparation for a bounce-back strategy where Wells Fargo wanted to go back to the already tarnished subprime lending. It is clear that subprime lending was a major revenue source for Wells Fargo bank and the bank was all the time willing to go back to this tarnished business due to good returns associated with it. After the settlement with the Freddie Mae, the bank announced its intentions to go back to subprime lending, albeit with modified requirements from the beneficiaries. Bouncing back to the subprime mortgage Wells Fargo was one of the first banking institutions and mortgage providers to bounce back to subprime mortgage market (Rudegeair & Conlin, 2014). This goes to prove that most banks are willing to forget lessons learnt in the past as long as there is a promise to make a lot of money. Wells Fargo had already started issuing loans to the subprime market as early as 2013, even before the subprime crisis was already over. In the new undertaking, Well Fargo, apart from observing the requirements of the Dodd-Frank law, also requires the customers to have a credit rating of at least 640 out of the possible 850 score in the American standard of measuring credit worthiness. The firm, amid crisis of subprime lending and the many law suits that affected it, including one from the New York mortgage authorizes, has gone back to lending and has looked at how it can lend to the people who may not be eligible for prime lending. Assessing the strategy Of course, as Wells Fargo tries to bounce back to the subprime mortgage lending, the question that is in most people’s minds is whether this will start another cycle that will lead to another credit crisis. There are various avenues to solve these issues. First, one can look at the issues with regard to how this will affect the bank. The bounce back strategy and future of Wells Fargo The strategy will either affect the future of Wells Fargo in a positive or negative way. First, it is evident that this will help Wells Fargo in expanding its market and making sure that Wells Fargo can access the neglected market. After the subprime crisis of 2008, many banks have shied away from lending money to the subprime market and this has left a very huge part of the market unattended (McKnight, 2010). If Wells Fargo will be able to handle the subprime market while at the same avoiding the negative aspects of it, it will be able to increase its revenue and the returns will be high. However, Wells Fargo will have to do this within the standards that have been set up to deal with the issues of subprime lending. Wells Fargo will have to work with a more restricted market in the subprime submarket especially in the context of the Dodd-Frank law and the national Mortgage Settlement Agreement. Not achieving this will only lead to more problems with the authorities and the firm will not benefit from its strategy to bounce back to the subprime market. If Wells Fargo fails to adhere with these requirements, this will only lead to negative impacts on its business. Wells Fargo’s bounce back strategy and the Economy As Rudegeair and Conlin (2014) argue, the decision by Wells Fargo to bounce back to the subprime mortgage market will have a positive impact on the economy. This is because it will spike up mortgage lending to the many people who have no enough create ratings to allow them to take prime mortgages. As the firm seeks to go back to the subprime submarket of the mortgage market, this has inspired a number of other big banks to reconsider this area that after the 2008 crisis has been seen as a no-go zone for mortgage providers and mortgage originators. As Wells Fargo inspires other banks to reconsider this neglected sector, there will be more money in the market and the many millions of Americans who are not eligible for the normal mortgages will be able to access the financing of their assets. As this happens within the context of the Dodd-Frank requirements, the high risk of the sector coming to a crisis will be lowered significantly and this will mean that the rates of defaulting by the customers will be lower (Aalberts, 2014). This will be important for the economy and is likely to improve it. Wells Fargo bounce back and the housing sector Needless to say, as the Wells Fargo’s attempt to go back to the subprime mortgage will be of significant help in boosting the housing sector once again. While the housing sector has received a lot of jeers and is now regarded with criticism and suspicion, the attempt by Wells Fargo will help to restore the housing industry and to boost the industry. Lending to the subprime market will mean that the industry will be useful in making sure that there are more people who can now benefit from mortgage funding (Madura, 2014). It is also at this moment important to realize that this will happen within the new and more regulated environment. The Dodd-Frank law, as already discussed has a number of clauses that help in protecting the mortgage consumers especially with regard to the subprime consumers of mortgage services (Immergluck, 2011). One of these sources of protection comes as a result of the law requirements that the mortgage providers be more customer-sensitive and be willing to refinance the mortgages as opposed to foreclosing the homes of the customers even without considering other alternatives to deal with a defaulting customers. When applied in this new environment, the subprime market will provide for a very important market for homes and this will provide for new homes to families that would otherwise not afford a home. This will be beneficial to Wells Fargo as a firm, the housing sector and the economy as a whole. Conclusions The attempt by Wells Fargo to go back to lending money and financing mortgages to the subprime market is a bold step. If well managed, it can lead to positive results for the firm. Wells Fargo only needs to tread carefully on this shaky ground and this will provide for a better and easier way to expand its market. It will need to access the market in a way that put up with with fresh regulations. Wells Fargo should be commended for its bold steps to reconsider the subprime market as this considered so many American who would benefit from the banks giving them a helping hand in achieving their American dream. Reference: Aalberts, R. (2014). Real Estate Law, 9th ed. London, Uk: Cengage Learning. Darbellay, A. (2013). Regulating Credit Rating Agencies. New York, NY: Edward Elgar Publishing. Engel, M. C & McCoy, P.A. (2011). The Subprime Virus: Reckless Credit, Regulatory Failure, and Next Steps. Oxford, UK: Oxford University Press. Gramlich, E. (2007). Subprime Mortgages: Americas Latest Boom and Bust. Washington, DC: The Urban Insitute. Immergluck, D. (2011). Foreclosed: High-Risk Lending, Deregulation, and the Undermining of Americas Mortgage Market. Ithaca, NY: Cornell University Press. Madura, J. (London, UK). Financial Markets and Institutions, 11th Ed. 2014: Cengage Learning. McKnight, D. (2010). Goodbye to All That?: On the Failure of Neo-liberalism & the Urgency of Change. New York, NY: Black Inc. Rudegeair, P. & Conlin, M. (2014, February 14). Wells Fargo edges back into subprime as U.S. mortgage market thaws. Retrieved April 27, 2014, from Reuters : http://www.reuters.com/article/2014/02/14/us-banks-subprime-insight-idUSBREA1D07820140214 Tighe, R.J. & Mueller, E.J. (2013). The Affordable Housing Reader. London, UK: Routledge. Valdez, S. & Molyneux, P. (2010). An Introduction to Global Financial Markets. London, UK: Palgrave Macmillan. Read More