Question

Regarding the 2007-09 Financial Crisis, Was an asset bubble involved? How did it form? Were low interest rates at least somewhat responsible? Why is it difficult for policy makers to prevent the formation of bubbles?

Answer 1

To answer this whether an asset bubble was the cause for the 2007-2009 Financial Crisis we need to understand the what is an asset bubble.

Asset bubble: It happens as and when prices of assets such as, stocks, bonds, commodities rise very fast without any changes in fundamentals of it.

• The bubble that was the reason behind the 2007-2009 crisis was the housing bubble. This happened due to the Federal Reserve lowered the rate of Federal Funds and created flood of liquidity in the economy.
• The two main reason behind the housing bubble were the subprime lending & the increase in housing speculation. But we have seen many people blamed financial institution, regulators and the policy makers for the crisis.
• The rates lowered by the Federal Reserve was somewhat responsible for the crisis, because of it liquidity in the market has increased and also caused for international trade imbalances.
• Policy makers makes policies that becomes the roadmap for others to act. In case of asset bubble that caused for the 2007-2009 financial crisis there are many regulators that have involved in it. Based on the directions and regulations formed by them market functions, but again when it comes to the identification of any bubble like thing that can cause such a collapse of the market takes time and we can't direct change the policies it goes through several discussions and then policy makers implement it.

Hence these are the reasons asked in above question.