Causes of the 2008 Crisis
The reasons for the 2008 housing market collapse and subsequent crash of many financial institutions are many. The converging lending practices that contributed to the crisis began with the 1998 repeal of Glass-Steagall, which separated regular banks and investment banks. This separation allowed regular banks to take on more risk.
A long period of low-interest rates encouraged people to acquire mortgages, and these same low rates caused asset managers to turn to high-yield mortgage-backed securities for better profits. Credit-rating agencies designated these securities as AAA, and fund managers trusted those AAA ratings and didn’t perform due diligence before buying securities. Derivatives were unregulated and were exempt from oversight or reserve requirements.
The federal government overrode state banking and lending regulations. Private lenders fed the demand with subprime mortgages such as interest-only mortgages, and in 2006, 84 percent of subprime mortgages were from private lenders. Fannie and Freddie joined the party late to protect their market share, but they did not largely precipitate the housing bust.
CECL (Current Expected Credit Losses) is a new accounting standard from the Financial Accounting Standards Board (FASB) that changes the methodology for determining the right level of balance sheet reserves of credit losses. Published in 2016, CECL will take effect in December 2019. It is meant to lower the risk that banks will accumulate bad debt. In theory, changes to lenders’ individual review policies should prevent a large number of bad loans to go on their books. At the least, it should alert them to the fact that they have bad loans on their books.
In direct response to the financial crisis of 2008, a number of regulatory changes were put into place. The most comprehensive set of regulations in the U.S. is under the umbrella of the Dodd-Frank Act. This act forces banks to keep more capital on hand to cover possible losses. It also requires them to keep consumer and investment divisions separate to prevent lenders from using company money for risky investments.
Banks with more than $50 billion of assets must undergo stress tests from the Federal Reserve. Also, the largest banks have an additional requirement of holding 3 percent of shareholder equity in cash or low-yield liquid securities.
Time to Invest
It has been 10 years since the housing crisis of 2008. Since then, the economy has largely recovered with continued growth in job creation, wage stability, investing and other economic indicators. The real estate market in Florida is beginning to see some steady increases in housing prices, but in areas where the difference between income and housing is low or rents outweigh mortgage payments, there are many excellent real estate investment opportunities.