Citigroup and Subprime Lending.

Date: November 6, 2009

To: Management

From: Mustapha Tarawally

Subject: Citigroup and Subprime Lending.

On September 6, 2000, Citigroup, Inc. announced an agreement to acquire Associates First Capital Corporation in an exchange of shares valued at thirty one point one billion. By then, the major profit source for CitiFinancial and the Associates was subprime lending (Baron, 2006, p.801). Subprime lending is the practice of extending credit to borrowers with certain credit characteristics  example a Fair Isaac Company (FICO) score of less than six hundred and twenty that disqualify them from loans at the prime rate (hence the term 'subprime'). Subprime lending covers different types of credit, including mortgages, auto loans, and credit cards. Since subprime borrowers often have poor or limited credit histories, they are typically perceived as riskier than prime borrowers. To compensate for this increased risk, lenders charge subprime borrowers a premium. For mortgages and other fixed-term loans, this is usually a higher interest rate; for credit cards, higher over-the-limit or late fees are also common. Despite the higher costs associated with subprime lending, it does give access to credit to people who might otherwise be denied. For this reason, subprime lending is a common first step toward “credit repair”; by maintaining a good payment record on their subprime loans, borrowers can establish their creditworthiness and eventually refinance their loans at lower, prime rates.

To add more, subprime lending practices can be analyze under utilitarian, right, and justice principle of ethics to ascertain the major problems associated with it.

Utilitarianism

This is an ethical principle that seeks to do the greatest good for the largest number of people lending (Baron, 2006, p.693). Under this ethical standard certain individual rights are expected to be sacrificed for the protection of the masses. The Equal Credit Opportunity Act (ECOA) prohibits discrimination in any aspect of a credit transaction. It applies to any extension of credit, including extensions of credit to small businesses, corporations, partnerships, and trusts. The ECOA prohibits discrimination based on:  race or color, religion, national origin and sex (Fair Lending Examination Procedures, 2006). The decision by Citigroup to invest in the subprime lending was for the interest of the majority. Almost more than sixty percent of the entire population of the United States falls under the middle class family with low credit ratings and limited disposable income, (Horne, 2009, p.410). So, the subprime lending initiative serves as means for these families to realize their American dreams by acquiring their own houses.

Rights

This principle of ethics relies upon the foundation that everybody in a society is entitled to certain guaranteed rights.  Individual rights are often at conflict between the world of legality and the world of morality. For instance, it should be assumed that everyone has the right to have their health taken care of by a government that taxes them to pay for unnecessary military weapons that don't even work when the order is put through, but if someone can't pay for medicine buys them illegally from another country they can be jailed (Berkley and Watson, 2009, p.3). Under this principle, there is an ethical obligation or duty as well as a right to do the thing in question. Also, every individual who is not a minor have capacity to contract and to meet the obligations of such contract. Citigroup have the moral and legal right to treat their customers fairly under the Truth in Lending Act. Also, Citigroup fails to explain the necessary disclosures associated with the subprime mortgages which result in hardship for some homeowners. These acts are referred to as mortgage fraud. Mortgage Fraud is defined as the intentional misstatement, misrepresentation, or omission by an applicant or other interested parties, relied on by a lender or underwriter to provide funding for, to purchase, or to insure a mortgage loan.

Justice

As the adage goes “those who come to equity must come with clean hands” Justice, then, is a central part of ethics and should be given due consideration in our moral lives. In evaluating any moral decision, we must ask whether our actions treat all per equally. If not, we must determine whether the difference in treatment justified: are the criteria we are using relevant to the situation at hand?  The growth in subprime lending was also driven by aggressive marketing by the subprime lenders (Baron, 2006, p.801). These aggressive acts violate the justice principle of business ethics. For instance, in a landmark case concluded in September 2002, the Commission charged that two of Citigroup Inc. subsidiaries, Associates First Capital Corporation and Associates Corporation of North America, engaged in systematic and widespread deception and other illegal lending practices. The Commission complaint alleged that the defendants at one time the largest subprime lenders in the United States lured consumers into high-cost loans through false and misleading statements and half-truths about loan costs, packed single-premium credit insurance into loans, and violated numerous federal laws, including the Truth in Lending Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act. The defendants paid two hundred and fifteen million for consumer redress to resolve the charges, in addition to a concurrent twenty five million class action settlement (Department of Justice, 2007, p.4).

Recommendations.

Citigroup are in business for the same reason as any other businesses – To make money.  Citigroup make money from fees, deposits held in your account and interest.  This amount must cover wages, technology and administrative expenses, bad loans and leave a little for the shareholders.  To ensure the Citigroup makes money requires viable investment and transparent business practices. On the other hand, business generally preach that the central focus of any business are the customers but, they are not treated them that way. They never live up to the mottos of corporate culture insisting that the customer is always right.   

The subprime mortgage investment will be a good investment plan if, it is carryout effectively and efficiently. One way to achieve positive return on investment from subprime lending is by inculcating corporate social responsibilities. Research studies have proved that businesses that uphold the concept of corporate social responsibility are those that survive during the economic downturns. Through Corporate Social Responsibility activities firms contribute to societal well-being by meeting consumer demand, providing jobs, developing new products, and paying taxes that fund public programs (Barons, 2006, p.653). This will help businesses align both market and non market issues for successful future dealings.

As for sales representatives, Citigroup should provide moral, professional, and official responsibilities training in order to acquaint their sales representatives on issues in meeting consumers as well as company’s goals. For someone to have a moral responsibility for some matter, means that the person must exercise judgment and care to achieve or maintain a desirable state of affairs. Professional responsibility arises from the special knowledge a person possesses. Mastery of a special body of advanced knowledge, particularly knowledge which bears directly on the well-being of others, distinguishes profession from other occupation. Official responsibility that is, a responsibility that someone is charged to carry out as part of his/her assigned duties (Beauchamp and Veatch, 1996, p.45). To crown it all, financial motivation will be base on how efficient and effectively these training procedures are adhering to in their daily routine by the sales representatives.