The Rise and Fall of the Housing Market
University of Maryland University College
August 18, 2011
The collapse of the housing market had far and wide ranging effects in the economy of the United States. While the effects were felt throughout the country, California, Florida, New York, Michigan, Illinois were dealt devastating blows to their respective economy. Throughout the country, foreclosures rose to staggering numbers and jobs lost were in the millions. This research paper will concentrate on the causes and consequences of the housing crisis and will attempt to determine if there is any fault for not controlling the crisis.
Causes of the Housing Crisis
The term bubble has been used synominously with the housing crisis. What is a bubble? According to the Webster dictionary an economic bubble is, “a state of booming economic activity that often ends in a sudden collapse.” American economist Robert Shiller of Yale University describes an economic bubble as “A bubble occurs when exaggerated expectations of future prices increase unusual demand either by people who fear being priced out of a market or by investors hoping to make a lot of money fast. A bubble is a self-fulfilling prophecy for a while, as successive rounds of buyers push prices higher and higher. But the willingness to pay higher and higher prices in fragile: It will end whenever buyers perceive that prices are no longer going up. Hence bubbles carry the seeds of their own destruction. Only time is needed for bubbles to end.” While there are many variations defining a bubble, all are consistent that there will be a “pop” or end to the bubble.
Over the last half of the century the US Government has pushed an intrinsic notion that owning a home is part of the American dream. The government has mad homeownership as a public policy goal and offers numerous incentives such as ability to deduct interest accrued from their mortgage and deducting property taxes. In 1938 during the Great Depression banks were strapped for cash as borrowers were defaulting on their loans. Through the authority of President Franklin D. Roosevelt and Congress created the Federal National Mortgage Association commonly known as Fannie Mae. Created as part of FDR’s New Deal, Fannie Mae was established in an attempt to raise home ownership levels and the affordable housing by providing banks with federal money to finance mortgages. Fannie Mae was set up to operate as a “national savings and loan,” banks now had the ability to offer loans to middle income buyers who otherwise would not be credit worthy. In 1968, Fannie Mae became a public company after enormous pressure during the Vietnam War to remove Fannie Mae’s debt portfolio from the government’s balance sheet. To prevent a Fannie Mae from monopolizing the industry Freddie Mac was instituted and also eventually went public in 1989. Fannie Mae consistently started initiatives such as the $10 billion “Opening Doors to Affordable Housing”, the goal was a commitment to offer loans to low to moderate income and special needs housing and at one point “one out of every seven home loans mortgages made in the US.”
While there is not a general consensus of when the housing bubble began, many economists feel when the Federal Reserve cut short term interest rates dramatically in 2001 “from about 6.5% to 1%” due to the crash of dot-com bubble was the start of the housing bubble. Prior to the drastic reduction in interest rates, the cost of owning a home and renting a home were almost identical. However, with low mortgage interest rates during this period saw the cost of owning a home drop drastically while the cost of renting a home did not and home ownership was on the rise. Homeownership rates rose from “63.9%” in the mid 80’s and saw a “7.8%” change from 1994-2004. While the percentage does appear to be small, to put the percentage into perspective there was an...
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