The financial crisis was largely built around new securities based on mortgage loans. The housing bubble brought down the financial system because panic spread from the subprime market to the entire global financial network. The federal government and the Federal Reserve engaged in a massive bailout to provide liquidity and keep the system from failing completely.
After the calamity subsided, the economy was in shambles. The stock market peaked on October 9, 2007. The S&P 500 crashed by over 50% in 16 months. In March of 2009 the market bottomed out and began to climb again. The real estate market is still falling, with no clear end in sight. Amidst the devastation, which was measured in trillions of dollars, federal regulators set their sights on cleaning up the mess.
New rules for mortgage brokers have been enacted by the Federal Reserve. The new rules change the game for both sellers and buyers. Home buyers are now required to put a down payment of 20% of the home’s purchase price in advance. This new down payment requirement is accompanied by strict income requirements in order to qualify for low interest rates. Credit Scores have also become much more important. Anything below a 650 will make getting a loan more challenging and result in much higher interest rates. Foreclosures going back as far as 7 years on a credit report are impacting borrows more than ever before.
The new rules are designed to establish conservative lending standards. These standards are meant to protect against the kind of abusive borrowing and lending that took place during the housing bubble. Banks are required to keep at least 5% of the loans they originate on their balance sheets. The new rules allow the banks to sell off the other 95% to securitization entities like Fannie Mae and Freddie Mac.
This means banks must hold more capital reserves. Costs for the banks and subsequently for borrowers could be raised. Mortgage lenders are also required to beef up their credit standards and tighten their credit requirements for new loans. Regulators are currently adhering to the idea of “risk-retention”; if lenders would keep more loans on their books, they would be more mindful of their risk.
Moral hazard was a ubiquitous problem during the housing bubble from 2003 to 2007. The new rules seek to curtail moral hazard. Concerns have been raised that the new rules are too stringent and will impede the recovery of the housing market. The market will likely find a new low and slowly recover. The stringent rules are designed to patch the holes in the financial system and ensure no crisis of this magnitude ever occurs again.