The 2008 Financial Crisis and the Housing Bubble
Introduction
The Financial Crisis of 2008 or the Great Recession was one of the most severe financial crises since the Great Depression and caused destruction and mayhem to the financial markets. There were several main causes to this recession including an artificially created housing bubble, the role of the government and the central bank, and bad investments made by financial institutions. The key to ensuring this does not occur again is by understanding why it happened. How do we as citizens understand and change our view of the government’s economic intervention to ensure disaster does not strike again?
The Housing Bubble
The housing bubble was caused by many different contributing factors including governmental encouragement in homeownership, institutions like Fannie Mae and Freddie Mac, adjustable mortgage rates, and greater risks taken on loans for mortgages. Beginning with the affordable housing requirements in 1992, the government began to place an emphasis on making home ownership achievable for all Americans. The American Dream was owning a home to governmental entities. Therefore, the government began to pass acts and laws that made it easier for people with a lower credit score to get a mortgage. By 2008, there were over 27 million low quality mortgages given out by banks. The government encouraged this even though it would have catastrophic consequences on the economy if a multitude of consumers default on their loans. Institutions like Fannie Mae and Freddie Mac did not help this crisis. These institutions bought many mortgages from banks on the secondary market, further inflating the housing bubble. This allowed unsustainable mortgages for both the consumer and the banks to take off despite many consumers not meeting the qualifications. However, people believed in Fannie Mae and Freddie Mac because they were started by Congress and had a federally mandated role so people believe Congress would bail them out if they began to fail. This meant consumers and traders felt more confident investing in them because of this implicit bias. Fannie Mae and Freddie Mac also encouraged banks to make nontraditional mortgages which involved both subprime and alt-a. A common practice for these specific mortgages was the adjustable mortgage rates where lenders would only have to pay 1% interest for 1-2 years and then the interest could be increased to 3-5% which meant many people could no longer afford their mortgage. Since the lenders were typically in worse financial situations, already had bad credit, and would not have received a loan in normal times, they often walked away and strategically defaulted on their mortgages. During 2008, over half of the mortgages owned by banks were low quality meaning many of these people did default on their loans causing the collapse of the housing bubble. However, much of this was very preventable. Owning a home is a great representation of the American Dream. However, there is a reason why the safeguards to gain a loan and a good credit score is an important indicator of whether someone will be a responsible homeowner. While the government had good intentions, they artificially stimulated the housing market, they encouraged banks to have low-quality mortgages, and they created federal financial institutions that were not regulated well. The housing market either needed to be heavily regulated or laissez-faire and the mix of both strategies led to a preventable financial disaster.
The Role of the Government
The government has played a significant role in every major crash of the USA’s economy. In this specific instance, Alan Greenfield and the Central Bank made several poor decisions that caused the Housing Bubble as well as inflation leading to an economic crash. The government decided to encourage home ownership to citizens by cutting interest rates to 1% from the Central Bank. However, in order to achieve this goal, the Central Bank needed a lot of money on hand (through taxes), it can borrow the money, or since it controls the monetary system, it can just create more money. Because we live in a digital era, Greenfield did not have to print money, instead he could use his computer to mark up the bank account essentially creating more money than there was. The low interest rate is a green light for entrepreneurs and citizens to stop saving and seize the opportunity. This system tricked the people into believing there was more money available, and that society was richer than it was. Our domestic pool of saving decreased and there was too much consumption which fed into the housing bubble. This bust and the boom of the economy was artificially created by the government and would have to come to a stop soon. Boom and bust cycles are part of economic systems and the government inflating the boom cycle and trying to prevent the bust cycle created an unsustainable situation that never should have been created in the first place. Once the financial crisis of 2008 began, the government wanted to help those who were facing financial hardship and so governmental programs increased and stimulus checks began. However, the government did not have the money from taxes to support these programs and our government deficit continued to grow higher and higher. This in fact, prolonged the bust cycle longer because it increased inflation and again sent missions to entrepreneurs and savers. The government, however, has had an ugly history of intervening in economic crisis since the Great Depression with Hoover and FDR. The government’s solution to a financial crisis has often been to create or print more money so they can fund their social programs, but the long-term consequences were not fully thought out.The government has been preventing bust cycles and is continually trying to reinvigorate the economy. However, boom and bust cycles are a natural part of the economy and for our economy to be more successful and for bust cycles to be less painful for the citizens then less regulations and intervention is required. While stimulus checks may sound like a good idea, they instead encourage people to do the wrong thing, spend rather than save, and it hurts the economy in the long run. I believe the government has good intentions but lacks the education and the ability to prevent boom and bust cycles and instead they end up hurting the economy worse and creating toxic cycles that are difficult to escape from.
Conclusion
While the idea of big government intervention in the economy may sound appealing, the government is not equipped to handle, understand, and prevent the natural cycles of the economy. Therefore, I believe our society would be better off with less restrictions on the boom-and-bust cycles, less intervention of the Central Bank, and less governmental intervention during bust cycles. The government ultimately does more harm than good in the long term for our economy through their regulations, they need to be watched and the consequences of their decisions need to be made clearer.