Question

The bursting of the housing bubble in 2007 and 2008 caused many personal and corporate bankruptcies. Many individuals lost their homes, and many banks went bankrupt. The tax payers spent around $1 trillion dollar bailing out many banks. Many things have been blamed for the housing bubble – fear and greed, corruption in the banking sector, too little regulation, too much regulation, and the Federal Reserve printing too much money. What caused the housing bubble and what changes to US laws or banking structure could prevent future problems?

Answer 1

What Is a Housing Bubble?

A housing bubble is a periodic effect in the real estate industry that drives up the average prices of houses and properties. This happens due to a boom in the industry that drives up the rates of buying homes to such levels, which are no more sustainable. This leads to a situation where the demand decreases or stagnates, and supply increases, resulting in a sharp drop in prices leading to a burst in the bubble.

What Factors Cause a Housing Bubble?

A housing bubble is the cause and effect of many factors working in tandem. With the economy going strong, credit growth is on a full swing leading to people willing to take more debt than they can afford. This leads to people having more disposable income to spend on housing. To capitalize on this surge in demand for credit, banks reduce interest rates and also loosen their lending standards leading to high levels of speculation and risky behavior. All this cumulatively leads to the housing bubble as people purchase properties that they could typically or previously not afford.

How to prevent future Housing Bubbles?

A crisis like the housing bubble is the cumulative effect of various factors, some of which are discussed above. To prevent a future occurrence of a similar situation, numerous checks must be in place primarily in the banking system.

• A vigilant body should be set up to monitor these numerous market lenders and to ensure that all follow proper lending norms. Currently, the Financial Stability Oversight Council under the Federal Bank oversees all such speculative lending.
• Banks should ensure proper checks are maintained and followed while lending and proper financial due diligence are done to establish the viability of the borrower. Minimum amounts for monthly maintenance of the borrower should adequately be set off before arriving at a loan amount.
• The government and FedBank should provide alternative instruments at attractive interest rates for investing to drive away from the speculation from housing purchases.