Real Cause of the Housing Market Crash 4 pages

Business Cycles: Phases, Indicators, Measures, Economic Evolution, Outlooks

is currently recovering from its worst recession in over 25 years. Most economists consider the rapid rise in housing prices (the bubble) and the subsequent collapse in that market to be the primary cause of the recession. Explain what housing market circumstances were responsible for the collapse of that market.

Observers attribute the 2001-2006 housing bubble to “everyone from home buyers to Wall Street, mortgage brokers to Alan Greenspan.” (

Causes were five-fold — and all reducible to the consumer:

REALTORS encouraged people to buy (and sell)

Builders built more homes than were needed. This was fed by the media’s emphasis on the American myth of each American needing a home to call himself. There was a home-buying mania.

Lenders created poorly designed loan products to fill demand. Economic derivatives, specially the “credit-default swap” were used irresponsibly in that swaps and other derivatives were sold and resold in ways that covered the amount of debt financial institutions were assuming. In the last stages of the housing boom, credit-default swaps in reference to mortgage-backed bonds were themselves bundled into financial instruments called collateralized debt obligations where buyers were essentially placing bets on whether bonds held by another would profit or fail. Risk became so great that in 2008, the Bank for International Settlements in Switzerland calculated that there was an approximate 0 trillion-worth value of derivatives across the globe up from $106 trillion in 2002. The derivatives had the reverse effect: intended to prevent doubt and uncertainty, they, instead, stoked insecurity and risk leading to Buffett’s statement that derivatives, in the wrong hand, can be harmful (NY Times, 2012).

Borrowers took risky loans to get more houses. There were also historically low interest rates.

Houses were the only investment that escaped taxes. Buyers took opportunity of easy credit and excessively bid uo the prices of homes

Sellers sold at irrational prices (Century 21) painted a more detailed picture. Quoting the Economist, they said that the housign bubble was causative to “layered irresponsibility … with hard-working homeowners and billionaire villains each playing a role.” Other factors not listed above were:

The Federal Reserve, which slashed interest rates after the dot-com bubble burst, making credit cheap causign banks to be generous in loans and people to be genours in buying.

Congress, that gave consumers tax incentive to buy more expensive houses.

Real estate agents, most of whom work for the sellers rather than the buyers and who earned higher commissions from selling more expensive homes.

The Clinton administration, that pushed for less stringent credit and downpayment requirements for working- and middle-class families.

Former Federal Reserve chairman Alan Greenspan, who encouraged Americans to take out adjustable rate mortgages.

Wall Street firms, who paid too little attention to the quality of the risky loans that lateer toppled banks

The Bush administration, which failed to regulate the securities market.

Collective delusion, that home prices would keep rising.

2. Economists classify macro-economic indicators as leading, lagging, or coincident. Define each classification and give two examples of each, relating them to the recession that began in 2007 and the recovery that is now under way.

An indicator is something that can be used to predict future economic patterns. Popular indicators include unemployment rates, housing starts, inflationary indexes and consumer confidence.

Indicators fall under one of three categories, each of which describes them:

1. Leading — these indicate — to some degree of accuracy — coming economic event. An example is bond yields which are thought to be a good leading indicator of the stock market since bond trader’s deal with speculation. Federal Reserve withholding of assets to bank results in fewer companies and fewer individuals being offered loans and therefore economic production will more likely suffer and there will be a rise in unemployment since money is scarce and few will be able to afford the short-term loans.

The Federal Reserve’s reducing short- and long-term interest rates is another leading indicator since people are more liberal in borrowing when it becomes cheaper to do so. Result: People are more willing to buy goods and services and companies are more able to hire others. Production is boosted leading to greater availability of goods and cheaper prices (since there is competition). This may well lead to a booming economy.

2. Lagging — This follows an event. It is an indicator that analyzes an event that has just occurred and confirms whether a pattern is occurring or is about to occur. If the unemployment rate, for instance, is raising this shows that the economy is doing poorly. If food prices rise, it shows that there is inflation and likely a recession with a drop in supply.

3. Coincident — These indicators occur simultaneous to the conditions which they analyze and they change at the same time as the economy or stock market changes.

An example of this is the rising level of wage or personal economics that drops and raises correspondent to economy. High personal income rates usually coincide with a strong economy. Hiring and firing of workers also coincide with economy.(Investopeida.)

3. All major economic indicators show the United States is recovering from the recession but that the process is not as strong as previous recoveries have been. If you were the President what would you do right now to help the economy recover so that the unemployment rate decreases faster than it has over the past two years?

In 2009, Obama signed the American Recovery and Reinvestment Act of 2009 (ARRA) otherwise known as the Stimulus Act which drew on Keynesian theory to create jobs as soon as possible and to help those hit by the recession (CBO (2012). The Stimulus package was based on Keynesian economics that argued that during periods of economic hardship, the government should step in by increasing public spending which would in turn stimulate more private spending by giving people the money to do so and by creating a large flow of money in the economy.

The Keynesian approach doesn’t always work. Britain had also used it to its detriment in the pre-Thatcher era. This was superseded by Thatcher’s Miltonian approach which too failed. It is the New Labor’s Mixed Economy approach that I would most recommend for Obama to employ in order to increase level of employment.

Britain’s New Labor government from 1994- 2010, created what they called a “Mixed Economy.” ‘Mixed economic’ approach refers to attempts to integrate right wing with left wing economic policies. This was accomplished in New Labor by the Party attempting to sufficiently detach them form capitalism to achieve the aims of socialism without totally relinquishing the capitalist approach. Pragmatically, New Labor perceived markets useful in empowering consumers to make their own decisions and to act independently (as in pollution). They, therefore, believed that market economics could be useful for social aims as wells for increasing economic efficacy.

At the same time, the New Labor party relied on public-private partnerships and private finance initiatives to raise funds and to dispel fears of excessive borrowing. The Private Finance Initiative (PFI) was announced in 1992 with the aim of achieving closer partnerships between the public and private sectors in order to increase involvement of private sector in providing public services. Under this PFI bill, the Government has been forced to rely on and hire more private contractors to accomplish its tasks (The Guardian, 2005.)

The socialist part could, on the other hand, be seen in that New Labor tried to replace to certain extent welfare with workfare. They were also high on regulation introducing commissions that included Commission for Health Improvement, Commission for Care Standards and so forth thereby rejecting pure laissez faire economics and, in fact, they introduced a host of regulations that controlled businesses and regulated corporate integrity.

In short, Britain’s Third Way stressed commitment to: balanced budgets, providing equal opportunity with the emphasis on personal responsibility, decentralization of government power, encouragement of public-private partnerships, improving labor supply, investment in human development, protection of social capital, and protection of the environment. The economy improved and unemployed lessened.

Sources “Who Caused the Economic Crisis?.”

Investopeida. What are leading, lagging and coincident indicators?

NY TImes,( 2012) Derivatives

Century 21 Hindsight Shows the Real Cause of the Housing Market Crash

The Guardian. (2012/jul/05/) PFI will ultimately cost £300bn

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