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Recession Info Center
Common wisdom on roots of the housing crisis:
The following are generally considered by the economic pundits as the main causes of the
housing crisis:
The following are generally considered by the economic pundits as the main causes of the
housing crisis:
- Popular notion that home values do not fall: While discredited by numerous
academic studies (e.g. studies by Robert Schiller from Yale), the popular notion that
home values are not subject to significant volatility and generally increase over time
is generally believed to have encouraged the housing craze. of 2002-2007 In fact, as
Schiller has shown, inflation adjusted U.S. home prices increased only about 0.7%
per year from 1940–2004, substantially lagging behind the growth in stocks.
Meanwhile, between 1997 to 2006, the inflation-adjusted home prices rose by 85
percent.
- Low interest rate: Historically low interest rates encouraged home buying.
Following the 2001-2002 recession, the Federal Reserve lowered the interest rates
to historically low levels. Between the year 2000 and mid 2002, the Fed reduced the
interest rate from 6.25% to about 1%. During the same period, the interest rate on
30-year fixed-rate mortgages fell from 7.5-8% to 5.5% and the interest rate on
adjustable rate mortgages fell from about 7% to 4%. Lower interest rate encouraged
and facilitated the housing craze that took over the country post 2002.
- Innovative, high risk mortgage practices: In addition to increasingly lax
standards and mortgage approval process, post-2002 also saw the boom of various
risky mortgage practices including subprime mortgages, adjustable rate mortgages,
stated income loans, and interest-only mortgages. While the details varied in each
case, by offering easy initial terms and lax credit checking standards, these vehicles
encouraged individuals or households who could not otherwise afford mortgages to
take on mortgages often on the belief that they would be able to quickly refinance or
sell/flip the house. As the housing prices began to fall, mortgage defaults and
foreclosures soared dramatically, exasperating the situation.
- Innovative financing: Through mortgage-backed securities (MBS), financial
institutions around the globe invested significantly in the U.S. housing market (often
highly leveraged investments), further encouraging high risk mortgage practices and
generally feeding the U.S. housing bubble.
- The Dot Com bubble: Economists like Robert Schiller have also noted that
following the crash of the dot com bubble in 2000-2001, the real estate market
became the primary outlet for the irrational exuberance that took over the stock
market in late 90's and early 2000.
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Subprime as a percentage of total mortgage originations.
