The Subprime Mortgage Crisis

Subprime denotes any type of loan which does not satisfy the prime guidelines of a loan. Subprime lending is a process of making loans or lending money to the borrowers who are not qualified to be given a loan at the market interest rates because of their low credit ratings (Bahin, 2007). Both the borrowers and the lenders find themselves in a riskier position as a result of subprime lending. It is so because such lending is characterized by poor credit rating, a high amount of interest rates associated with it, and unfavorable financial situations. The mortgage brokers played an important role in the rise and fall of financing related to subprime mortgages. The competition corresponding to the subprime loans increased as a result of the increasing demand of Mortgage-Backed Securities (MBSs) sought by the investment banks. The lenders were observed to be involved in activities of introducing innovative financial products which seemed to be attractive to the borrowers, and the latter was thus becoming more and more interested to borrow money from the lenders. If we consider the job responsibilities of mortgage brokers, it can be observed that they had to perform the activities related to identifying the borrowers, receiving an application for a loan from the borrowers, assessing their creditworthiness, evaluating their income-to-debt ratios, and then finally sending the borrowers to the lender who meets all the criteria. However, it is worth mentioning that all these activities and processes followed by the mortgage brokers did not correspond to the actual plan. The mortgage brokers received emoluments in the form of commissions and, therefore, it worked as an incentive for them to earn greater commissions by sending even the prime credit borrowers to the subprime lenders. Even the people who had little knowledge about MBSs were attracted to them because of the increasing demand for them in the market. There were not even any kinds of licensing requirements for a person to become a mortgage broker (Sanders, 2002). All these factors led to the emergence of mortgage brokers in the market and had an impact on lowering their reputations. The lenders have exposure to such a huge number of participants in the mortgage industry that many of the borrowers received loans who should never have been lent money because they were to face financial problems while repaying the loans received by them.Based on the above evaluation of the situation it can be concluded that besides some of the minor incidents, certain specific individuals like mortgage brokers cannot be blamed for the downfall of the overall subprime mortgage lending process. The blame should actually go to the regulatory authorities and government institutions which failed to oversee the situation beforehand, to different corporate misdeeds, motivation to earn more profits, and also, to a large extent, to the borrowers themselves.Incentive contracts or managerial incentives in a corporate organization mainly correspond with the agency theory and the problems associated with it. Jensen and Meckling (1976) are commonly associated with the term agency theory as found in most of the existing literature. According to Alchian and Demstez (1972), the business activities conducted by most of the organizations are mostly governed through contracts that involve voluntary exchanges.