Responding to the Subprime Mess: The New Regulatory Landscape

Abstract

An era of unregulated financial markets has resulted in a global financial disaster the likes of which has never before been seen. Central banks of all major countries, and the governments of these countries, are scrambling in uncharted waters to avoid a complete meltdown of the worlds' financial markets. More than a trillion dollars has been allocated to try to fix the mess.How did we get to this point? The unlikely culprit was residential mortgages in the United States. Regulatory bodies took no action while this market grew with increasing acceleration, increasing irresponsibility, and increasing greed. One of the great financial bubbles was created. Financial instruments were created, given an imprimatur by rating agencies, and sold the world over. These seemingly secure investments, backed by mortgages on residences in the United States, were purchased by millions of unwary investors, even the most sophisticated investors, and on an unparalleled international scale. The investment banks, anxious to ride a wave of profitability, created more and riskier investments as the bubble inflated. Part II of this article describes the mortgage landscape which predated the collapse.In 2006, the housing market peaked and began its crash, bringing with it all of the purchasers of the mortgage backed financial instruments.All the players in the residential housing market were devastated. Homeowners lost their homes. Mortgage lenders disappeared. Investment banks either went out of business, or merely survived thanks to government infusions of cash. Investors in the mortgage backed securities lost virtually all the value of their investment. And stock markets around the world crashed with a resounding thud, wiping out vast amounts of wealth.How did this happen. Where were the regulators? What are the weaknesses in our residential mortgage funding system? Part III of this article analyzes the mortgage market, its weaknesses, and its regulatory scheme. The causes of the problem, namely irresponsible borrowers, greedy lenders, unresponsive regulators, the overzealous mortgage backed securities market, the rush by foreign investors to place money in U.S. investments, the irresponsibility of the credit rating agencies, and the collusion of appraisers, are discussed and scrutinized.Part IV breaks down the new regulations and legislation enacted in the wake of the financial meltdown. Part V examines Fannie Mae and Freddie Mac, their ultimate decline, and resulting takeover by the federal government.Part VI discusses and analyzes the various lawsuits which have arisen from the mortgage meltdown.Finally, Part VII attempts to specify weaknesses in the residential mortgage funding system, and to propose elements which must be addressed in creating a more stable, yet responsive mortgage market in the future.