Why did the Housing Market Crash? There are many people who are asking this question and most of them did not recognize the irrationality during the housing bubble nor had the foresight that the housing bubble would collapse. Most people didn’t acknowledge that we had a bubble and still fail to understand that we continue to have an artificial Real Estate market that is overvalued for the very same reasons that caused the housing bubble to inflate. An asset class can still be artificially overpriced despite having dropped from its all time high. Instead of asking why the housing market crashed, it is much more valuable to ask the question of what created the housing bubble in the first place. To financial historians not surprising, the very variables that made the housing bubble possible are now part of the solution to “fix” the real estate market. More anti-free market policies, more Government interference to continue distorting the markets…
Contrary to the misconception that it was the free market that made the housing bubble possible it was interference in the market place that distorted the demand and supply variables for credit and real estate. The Federal Reserve greatly distorts the supply and availability of money with its anti-free market loose interest rate manipulation. The Government also interferes in the market place with non-sense guarantees of home loans made through Fannie Mae, Freddie Mac, USDA, and VA.
In a free market system the cost for credit is dictated by the market forces that consist of the relationship between the demand for credit and the availability of savings to be lent. In addition to this demand and supply relationship the lender charges a risk premium to the interest rate for the loan. In times when the savings rate is high, interest rates would come down as much money is available to be lent. On the contrary, during periods when people save little the cost for credit would go up as the availability of savings to be lent is scarce. This would also encourage saving in times when the National savings rate is low, while a low cost for borrowing would naturally encourage people to borrow money for investments and consumption during times of high savings.
It wasn’t the free market that encouraged malinvestment and speculation. It was the Government guaranteeing home loans through various agencies such as Fannie Mae and Freddie Mac that eliminated risk as the lender would have the ability to make loans while the Government guaranteed its potential losses. As such there was no incentive to lend money conservatively as doing so would restrict the number of transactions while not minimizing potential losses since these losses were absent due to the Government guarantees. To make matters worse, Republicans and Democrats alike voted several times to increase the FHA loan limit during the housing bubble. This allowed people to take on greater debt and perfectly illustrates that government subsidies do not lower the price but make the underlying assets more costly. By raising the FHA loan limits the Bureaucrats in Washington voted to extend the housing bubble, raise prices, and delay the inevitable correction.
While many self-proclaimed conservatives blame the Democrats for the social programs and anti-free market policies it was President Bush in 2002 who stated that a high down payments are a big barrier to first time owners. During “A Home Of Your Own” conference on May 17, 2002 President Bush urged Congress to use taxpayers money to interfere in the market place by lowering down payments for those that cannot afford to buy a home. During that speech President Bush also explained how the guarantees of home loans by the Government Sponsored Enterprises would streamline the underwriting process and basically neglect the risk variable. President Bush made it clear that his and Congress’ vision is to make homeownership a right and not a privilege.
“A third major barrier is the complexity and difficulty of the home buying process. There’s a lot of fine print on these forms and it bothers people, it makes them nervous…and so therefore what Mel [previous HUD Secretary] has agreed to do, and what Alfonso Jackson [current HUD Secretary] have agreed to do is to streamline the process, make rules simpler so that everybody understands what they are, makes the closing much less complicated. We certainly don’t want there to be a fine print to prevent people from owning their home. We can change the print….that will have a powerful impact…”
This type of market interference in addition to the Federal Reserve manipulating short term rates to historic lows greatly increased the demand for housing and extended cheap credit to people that otherwise wouldn’t have qualified. It wasn’t the free market that encouraged malinvestment and led to financially flawed business decisions. It was a continuation and expansion of big government policies, brought to us by both Democrats and Republicans. The Fed’s loose monetary policy with artificial low interest rates in combination with socialist and corporatist housing policies by the Government provided the foundation for the biggest housing bubble in history.