The Subprime Crisis - Some Thoughts on a 'Sustainable' and 'Organic' Regulatory System

The Nation is now in the midst of one of the greatest financial crises in its history. Much of the blame for this condition is being placed on the bursting of the residential real estate bubble, which was fueled in large part by the reckless expansion of subprime mortgage lending. Those mortgages began defaulting in droves as the Federal Reserve Board drove up interest rates, causing massive losses at Bear Stearns, Lehman Brothers, Morgan Stanley, Citigroup, Wachovia, Washington Mutual, Countrywide Financial Group, American International Group and Merrill Lynch, to name a few. Those losses were shocking but paled in comparison to the failures of Lehman Brothers and Bear Stearns and the placing of Freddie Mac and Fannie Mae into conservatorship. Massive bailout packages for the financial service firms failed to restart lending, the country slipped into recession and unemployment soared. The subprime crisis had other ripple effects. The Dow Jones Industrial average was down 47 percent on February 19, 2009 from the high of 14,087 that was reached on October 1, 2007. This devastated retirement savings, college and other endowments, and every other investor in the market.On the other side of the equation were the subprime borrowers. They too were devastated by the subprime crisis as their adjustable rate mortgages (which had been originally issued at low "teaser" rates) reset at unaffordable levels. Foreclosures became an epidemic in many communities across the country, Florida being one of the worst centers for those sad events. Hispanics were also a particular target for subprime lenders. Hispanic homeownership in the United States grew by 47 percent between 2000 and 2007, compared to an overall homeownership increase of 8 percent. Tellingly, that growth was fueled by the fact that some 47 percent of mortgage loans to Hispanics were subprime and many of those loans are now being foreclosed. The African-American community has also been hard hit by the subprime crisis. Over one half of mortgage loans to African-Americans in 2006 were subprime, and they too are facing massive foreclosures. These problems have been blamed on flaws in the financial regulatory structure, and Congress has now begun the process of restructuring that regulation. This Article discusses the subprime mortgage market and the flaws in the financial system that led to the present crisis, and it will then provide some suggestions on regulatory reform.