2007 Housing Market Bubble
2007 Housing Market Bubble
The 2007 housing crash was the worst bubble burst experience that has ever been encountered in the U.S. history, an occurrence that led to financial crisis. It is important to appreciate the fact that different factors led to the housing bubble of 2007, with some of the primary causes being the credit crunch that was caused by the housing bubble. Nathsanson & Zwick (2015) assert that irrational exuberance is among the aspects that led to the development of a ripe environment for the growth of housing bubble hence contributing to the financial crisis in the U.S.A. Furthermore, different factors that contributed to the crisis are explained and how the regulators failed to control the situation leaving price for homes to go unchecked for decades (Huang & Yeh, 2015). Moreover, some of the important strategies that are implemented to help in reforming the situation to support the impressive growth of the economy include the requirement of the policy regulators to control the dynamic prices of homes in the country.
Failure to manage the housing market led to rapid increase in the price of the houses, with the peak experienced in 2006 but later declined to result in bubble burst that led to the financial crisis in the country. Apparently, the explosion resulted in increased reporting of foreclosures that were experienced in 2006-2007, an occurrence that was noted to bring an enormous risk to the country's economy (Huang & Yeh, 2015).
1. Causes of Housing Bubble
The different practices carried out by the policy controllers like the reduction in the short-term interest rates and relaxation of the mortgage standards. However, an important aspect that should be noted in the above study is that housing bubbles is a global concern and has been felt almost everywhere although the intensity of the impact varies depending on the economic conditions of a state. However, not much is understood on the transfer of housing bubble from one region to another or the extent to which it can be impacted.
The escalating prices of houses in the U.S. that was experienced from early 2000 was a mystery to many as it was not clear how such an economy would let the trend occur yet it had all the power to bring the situation under control. Nathanson & Zwick (2015, August 3) asserts that an incident of the housing bubble is only expected to occur in an area of limited land where it is difficult to build new residents to cater for the rising demand. However, a city like Las Vegas still had the potential to build more houses and with the available resources, it had the jurisdiction to manage stable prices. However, different scholars explained their concern on the issue highlighting irrational exuberance that was experienced in the country as the principal cause of the burst (Nathanson & Zwick, 2015). Nonetheless, the price of houses in the country rose because the investors in the housing market valued the price of land to be too high, an aspect that led to the burst. Further studies indicate that the tremendous increase in the house prices was due to the investors’ short-term view of the different factors that are involved in the construction of the homes.
There are two primary motivations for the above study to understand the causes and impact of the housing bubble as will be explained. The first objective is to comprehend the common understanding that there exists a significant relation between the consumption level and housing wealth an aspect that is yet to be confirmed. However, different scholars have asserted previously that level of household consumption has a significant influence on capital, hence affecting the economy in general. Furthermore, controlling asset bubbles could impact positively on economic growth because if the incident is left unchecked, it leads to severe economic challenges (Shih et al., 2014). Hence, through the policy tools, the house market regulators can effectively manage the bubbles because if the condition is left unchecked, it will result in a negative impact that will adversely affect the country's national income.
It is vital noting that during the 2007 financial crisis, there was an influx of saving that was coming from other countries with better economies and better saving habits like Japan and Brazil. The above trend maintained the mortgage interest rates to be significantly low an aspect that made the investors seek investments with little risks but experienced better proceeds. Therefore, the low mortgage rate experienced contributed to the incident of the housing bubble as affordable payments were experienced in the country despite the rising house prices (Pollock, 2015).
Low short-term interest rates
It is paramount noting that the federal funds rate was significantly low from 2002-2004 with an expectation to enhance the country's economy. Furthermore, it was expected that the country would recover from the recession a state that had negatively impacted on the growth of the country's economy that had been experienced in 2001. The Federal Reserve was significantly lowered from 6.5 to 1.75 which a significant drop but still had no positive impact on the economy as it still proved sluggish. Therefore, the low short-term rates are among the primary factors that contributed to the housing bubble experience in the U.S. economy (Nneji et al., 2015).
The above incident of housing bubble can be explained in two varying ways. The first explanation is that it employed the use of adjustable rate mortgage (ARMs). Because of the escalating house prices, the rate at which the house prices were rising was significantly higher than their income an aspect that rendered the property to become expensive as only a few people could afford the payments using the fixed rate mortgage. Hence, the use of ARMs guaranteed the buyers of cheap monthly rates as the short-term package proved to be affordable as compared to the former (Shih et al., 2014).
The use of ARMs was employed in the housing market an aspect that led to the increased use of the concept as it made monthly payments of houses to be affordable for many people while at the same time leading to increased house prices. Moreover, another impact of the short-term rates is that it contributed to increase leveraging in that investors were willing to take more short-term loans at low rates to invest in the long-term schemes. Therefore, the high leverage incidents led to more mortgage loans an aspect that resulted in escalating home prices leading to the housing bubble. Hence, it is important to appreciate that deleveraging is essential in any economy as it helps lower the house prices and significantly stabilize the economy (Basco, 2014).
Relaxed standards for the mortgage
Different facets led to the relaxation of the mortgage loans which include the following; the set policies of the government are meant to subsidize house prices and increase ownership of homes by the low-income households. Furthermore, the regulations were also aimed at increasing competition of the mortgage loans among other significant elements associated with the mortgage package. Before the housing bubble incident, the mortgage loan standards were unswerving with almost similar regulations (Shih et al., 2014). Over the decades, the state has pushed to enlarge the number of house ownership amid lower-income members by relaxing standards for the advance loans significantly including the nationalized banks.
With the current trend of globalization and increased use of the internet, most people are using the internet to access mortgage loans that offer the lowest rates. Furthermore, the increased competition in the business has resulted in the relaxation of the mortgage standards an aspect that has led increased market share as more people are buying the loans. Another aspect that leads to the relaxation is the introduction of the subprime mortgages that is meant to cater for loans to the poor credit risk.
The above fact is also considered to have considerably contributed to the state of the housing fizz with an expectation of an increase in the price of houses. According to scholars, the concept is meant to control the escalation of prices of commodities in the market due to speculations an aspect that was practiced by the government agents, banks, investors among others. For example, most of the economist analysts were noted to air their views that they expected the family homes to experience a rise in price for almost have a century and at no point do they expect the same to fall (Miles, 2015).
The speculation was however justified by the notion that the prices had not declined since the experience of the great depression an assumption that made most people to believe the thought. Hence, the fact that most people thought in such assumptions made people make irrational decisions that cultivated a conducive environment for the housing bubble. Moreover, the government failed in its responsibility to manage the expanding dwelling prices, therefore, enhancing the use of ARMs in accessing loans and use subprime loans. Furthermore, to counter the case of the high prices of homes, banks offered people the leveraged mortgages with security an aspect that contributed to the situation further (Feng & Wu, 2015). The case was speculated in 2002 a concept that was predicted to occur due to a significant increase in the house costs that was experienced in the United States. The speculations that occur during incidents of price bubbles are difficult to recognize or avoid despite the fact that it was considered to be an ideal investment by most people.
Results of Housing Bubble
The bursting of house prices was experienced in the country resulting in a condition of financial crisis with the costs of homes reaching its peak in 2006. However, fall in prices was experienced in 2007 an aspect that contributed to a sudden increase in the mortgage default. The condition discouraged various populaces from purchasing homes owing to the sudden shrink in the prices. For the case of the investors using the AMRs concept, the drop in prices meant that they could not effectively manage their financial needs as they were expected to experience negative equity. A sudden increase in their monthly payments with foreclosure rates of AMRs increasing by almost 400 percent explains this occurrence. The foreclosures experienced made most of the homeowners to the sale of their investments as they experienced negative equity. The behavior discouraged the banks from giving out mortgage loans an aspect that significantly eliminated the principal sources of loans leading to further decline in the prices.
The bursting made most people to experience a decrease in the dwelling prices that caused significant loss being experienced by different stakeholders who had invested in the home souk. Furthermore, it is important to appreciate that most of the losses experienced were felt more by the financial system other than the home owners. The first group that felt the impact include the mortgage lenders as it led to their declaration of bankruptcy an indication of the financial crisis that being experienced by such stakeholders. Most of the major investment banks in the U.S. issuing mortgage loans were also affected by the burst and the foreign investors who had ventured into the business.
Therefore, the bursting impacted negatively on the economy in different ways as will be explained below; construction of homes as a significant economic activity with material effect on the growth of an economy and decline in the same would result in a decrease in GDP. Furthermore, the effect would cause a drop in the consumption that is experienced by the different households in the country as their wealth would have been impaired. Moreover, the bursting brought many negative impacts than the predictions as it paralyzed most of the financial systems, caused an increase in the financial risks among other issues. Therefore, the rise in the financial risks made it difficult for most of the stakeholders wishing to access loans for different tasks to be a real menace. The above situation, therefore, led to a decrease in the actual investment by over thirty percent as revealed by the 2007-2009 financial analysis.
Historically, the bubble is presumed to have originated from the 1990 boom that was experienced in the U.S. as most people had a lot of wealth that increased their consumption rate with the house being one of the commonalities that were highly valued. Therefore, the demand for houses rose while the supply for the same was fixed leading exaggerated prices for the commodity and development of a belief that prices of houses were expected to increase continuously in the future. However, statistics indicated that the country had previously held stable prices for homes for decades but had suddenly escalated due to the speculative bubble rather than real issues that influenced the housing market.
Managing the bubble would be the most important move for any economy and an aspect that will be significantly appreciated by many in the society as it will lead to reduced home prices and low rates in the rent. However, to achieve the above objective, it is worth noting the importance of regulators to control the manner in which the housing market is controlled. Hence, it is important to inform the regulators of the negative impact created by the bubble so as to manage the situation before it is out of hand to abolish a culture where the appraisers give overvalued appraisals on commodities. It is the responsibility of the regulator to control the growth of the housing bubble and should thus be blamed for the financial crisis that was experienced in the country as they left it to grow unchecked (Feng & Wu, 2015).
Moreover, the organization had great tools to control accommodation bubble by stopping the abuse of mortgage and monetary bazaar that contribute to significant swell in the residence cost in the country. Fed had the responsibility to issue the sound warning to the practices; it would have made the other regulators managing the mortgage and credit finance, to put more restrictions that will restrict the abuse. Furthermore, the Fed had the responsibility of implementing standards that should be practiced by the different actors in the housing market hence be in a position to manage housing bubble (Yu & Hongru, 2015). The housing bubble that was created in 2007 cultivated an environment that sustained financial abuse in the economy that could go undetected for years, an aspect that will negatively impact on the economy. Furthermore, the bubble did not affect most of the stakeholders until the moment that prices of the houses started to decrease leading to closures being experienced.
The bursting of the bubble led to the 2007 recession an aspect that contributed to financial catastrophe in the country influencing the accessibility of loans by different stakeholders. The above paper has highlighted fundamental causes of the home bubble and resulting impact that negatively affected the U.S. economy. The different facets that led to housing bubble had a varied influence on the case and scholars have however noted that even if any of the factors were absent, it would not have prevented the incident from occurring. However, the irrational exuberance cannot be assumed as it is believed to have a significant impact to the housing bubble as through the concept; people had believed in the various assumptions that house prices would consistently increase. In conclusion, we can assert from the study that bubble lead to increased prices of assets from the initial values as people are made to believe that prices of commodities are expected to escalate in the future and negatively impact the economic growth of any country. Furthermore, the financial bubbles should not be assumed as natural calamities that are beyond control but can be contained by central banks of a country or Fed to prevent their growth.
Basco, S. (2014). Globalization and financial development: A model of the Dot-Com and the Housing Bubbles. Journal of International Economics, 9278-94.
Feng, Q., & Wu, G. L. (2015). Bubble or riddle? An asset-pricing approach evaluation on China's housing market. Economic Modelling, 46376-383.
Huang, M., & Yeh, L. (2015). Should the Fed take extra action for the recent housing bubble? Evidence from asymmetric transitory shocks. Journal of Economics & Finance, 39(4), 762-781.
Miles, W. (2015). Bubbles, Busts and Breaks in UK Housing. International Real Estate Review, 18(4), 455-471.
Nathanson, C., & Zwick, E. (2015, August 3). Did irrational exuberance cause Vegas’ housing bubble?. Retrieved February 2, 2016, from http://insight.kellogg.northwestern.edu/article/making-sense-of-las-vegas-housing-bubble
Nneji, O., Brooks, C., & Ward, C. R. (2015). Speculative Bubble Spillovers across Regional Housing Markets. Land Economics, 91(3), 516-535.
Pollock, A. J. (2015). The temptations of housing finance bubbles. Housing Finance International, (12), 12-13.
Shih, Y., Li, H., & Qin, B. (2014). Housing price bubbles and inter-provincial spillover: Evidence from China. Habitat International, 43142-151.
Yu, Z., & Hongru, G. (2015). Is Shenzhen Housing Price Bubble that High? A Perspective of Shenzhen Hong Kong Cross- Border Integration. International Real Estate Review, 18(3), 365-382.