FINC 660
Andrew Smith is a loan officer at Peach Savings and Loan Association. His high school friend John Black never worked a proper job and makes a living by part-time seasonal jobs and with the help of family members. He always has financial troubles. He is married and has two children.
Andrew suggests to John that instead of struggling with rent payments, he can borrow a mortgage loan from Peach and buy a house where he can live with his family. He tells him that the interest rate would only be 0.1% and does not see it necessary to inform him that rates would reset to a 10-year US government bond rate plus 3% after three years. He believes that he will be able to sell the house at a higher price anytime he wants. He tells him that housing prices have tripled in the last decade and will continue to rise at the same pace, so he will never regret making this investment.
Despite John’s financial problems, Andrew does not care too much about John’s ability to pay and Peach suffering loan losses. He assumes that, like many other similar loans, his employer, Peach, would sell this loan to Willards Investments. This major investment bank is very active in the securitization of mortgage loans. Willards Investments pools hundreds of similar kinds of loans into mortgage-backed securities (MBS). Low documentation loans mainly back these securities, and loan-to-value ratios are high.
Willards Investments has a long-time business relationship with White Ratings, which always provides more favorable ratings than other companies. White Ratings issues high credit ratings for these MBS because default rates have only been 2 % in the last three years.
Frank Chandler works as a research analyst at Willards Investment. He trusts the high ratings issued by White Ratings and recommends a “strong buy” for the securities without any details. Willards Investment distributes commissions on the total amount of MBS sold to investors among research, corporate finance, and investment banking divisions.
Maria Hart manages several pension fund portfolios. She had underperformed benchmarks for several consecutive quarters and risks losing some of her best accounts. Her boyfriend informs her about their “strong buy” recommendation the day before the report is published. Maria expects that the recommendation would create a strong demand for the securities after publication and buys the securities for the pension funds she manages.
Please discuss the financial analysis, recommendations, and actions mentioned above from an ethical perspective.