The Mortgage Meltdown
October 1, 2015
Although many people, organizations, policies and regulations contributed to the creation of the housing bubble and the subsequent financial 2008 crash, the root of the problem was the availability of cheap money for housing purchases.
After the dot-com bubble, the Federal Reserve stepped in and reduced key interest rates to avoid a recession. This approach tried to encourage economic activity and resulted in low mortgage rates. Wall Street firms rushed to lend money and started pushing money into the mortgage market.
For the Fed, new debt-money creation meant economic stimulation, but this combination of increased home inventory, relaxed lending practices and investors treating homes as commodities caused a price bubble.
- Home prices grew rapidly across the nation. From 2000 to 2006, the median sales price of existing single-family homes rose by 56%, or 7.7% per year.
- Markets such as Las Vegas, Florida and California, experienced even higher increases.
- A construction boom ensued and many houses became a commodity for trading, rather than properties where people lived.
Meanwhile the housing inventory kept increasing and government officials encouraged home ownership. The role that government-sponsored enterprises played in this crisis was significant too because they created a potentially endless supply of money to buy mortgages.
The private financial institutions' responsibility lies in having pooled large collections of mortgages together into a bundle and selling the package to investors as a mortgage-backed securities.
When the bubble finally burst, housing prices fell and foreclosures rose, financial institutions started collapsing, other areas of the economy were harmed as credit froze almost overnight and the stock market declined sharply. At the same time the federal government became heavily indebted trying to avert a financial disaster.
Source: Chanan Steinhart, "The Mortgage Meltdown," National Center for Policy Analysis, September 29, 2015.
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