Observers and analysts have attributed the reasons for the 2001–2006

housing bubble A housing bubble (or a housing price bubble) is one of several types of asset price bubbles which periodically occur in the market. The basic concept of a housing bubble is the same as for other asset bubbles, consisting of two main phases. Firs ...

and its 2007–10 collapse in the

United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...

to "everyone from home buyers to Wall Street,

mortgage broker A mortgage broker acts as an intermediary who brokers mortgage loans on behalf of individuals or businesses. Traditionally, banks and other lending institutions have sold their own products. As markets for mortgages have become more competitive, ...

s to

Alan Greenspan Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...

". Other factors that are named include " Mortgage underwriters,

investment banks Investment banking pertains to certain activities of a financial services company or a corporate division that consist in advisory-based financial transactions on behalf of individuals, corporations, and governments. Traditionally associated wit ...

rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may ra ...

, and investors", "low mortgage interest rates, low short-term interest rates, relaxed standards for mortgage loans, and

irrational exuberance "Irrational exuberance" is the phrase used by the then-Federal Reserve Board chairman, Alan Greenspan, in a speech given at the American Enterprise Institute during the dot-com bubble of the 1990s. The phrase was interpreted as a warning that the ...

"A Summary of the Primary Causes of the Housing Bubble and the Resulting Credit Crisis: A Non-Technical Paper
By JEFF HOLT Politicians in both the Democratic and

Republican Republican can refer to: Political ideology * An advocate of a republic, a type of government that is not a monarchy or dictatorship, and is usually associated with the rule of law. ** Republicanism, the ideology in support of republics or agains ...

political parties have been cited for "pushing to keep derivatives unregulated" and "with rare exceptions" giving

Fannie Mae The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the N ...

and

Freddie Mac The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia.

Government policies

Housing tax policy

In July 1978, Section 121 allowed for a $100,000 one-time exclusion in capital gains for sellers 55 years or older at the time of sale.1. Proposal for Amending I.R.C. §121 and §1034
''U.S. House of Representatives'' In 1981, the Section 121 exclusion was increased from $100,000 to $125,000. The

Tax Reform Act of 1986 The Tax Reform Act of 1986 (TRA) was passed by the 99th United States Congress and signed into law by President Ronald Reagan on October 22, 1986. The Tax Reform Act of 1986 was the top domestic priority of President Reagan's second term. The ...

eliminated the tax deduction for interest paid on credit cards. As mortgage interest remained deductible, this encouraged the use of home equity through refinancing, second mortgages, and home equity lines of credit (HELOC) by consumers. The

Taxpayer Relief Act of 1997 The Taxpayer Relief Act of 1997 () reduced several federal taxes in the United States. Starting in 1998, a $400 tax credit for each child under age 17 was introduced, which was later increased to $500 in 1999. This credit was phased out for h ...

repealed the Section 121 exclusion and section 1034 rollover rules, and replaced them with a $500,000 married/$250,000 single exclusion of capital gains on the sale of a home, available once every two years. This made housing the only investment which escaped capital gains. These tax laws encouraged people to buy expensive, fully mortgaged homes, as well as invest in second homes and investment properties, as opposed to investing in stocks, bonds, or other assets.

Deregulation

Historically, the financial sector was heavily regulated by the Glass–Steagall Act which separated

commercial Commercial may refer to: * a dose of advertising conveyed through media (such as - for example - radio or television) ** Radio advertisement ** Television advertisement * (adjective for:) commerce, a system of voluntary exchange of products and s ...

and investment banks. It also set strict limits on Banks' interest rates and loans. Starting in the 1980s, considerable deregulation took place in banking. Banks were deregulated through: * The

Depository Institutions Deregulation and Monetary Control Act The Depository Institutions Deregulation and Monetary Control Act of 1980 (, ) (often abbreviated DIDMCA or MCA) is a United States federal financial statute passed in 1980 and signed by President Jimmy Carter on March 31. It gave the Federal Res ...

of 1980 (allowing similar banks to merge and set any interest rate). * The

Garn–St. Germain Depository Institutions Act The Garn–St Germain Depository Institutions Act of 1982 (, , enacted October 15, 1982) is an Act of Congress that deregulated savings and loan associations and allowed banks to provide adjustable-rate mortgage loans. It is disputed whether the a ...

of 1982 (allowing Adjustable-rate mortgages). * The

Gramm–Leach–Bliley Act The Gramm–Leach–Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999, () is an act of the 106th United States Congress (1999–2001). It repealed part of the Glass–Steagall Act of 1933, removing barriers in ...

of 1999 (allowing commercial and investment banks to merge).

Federal Home Loan Bank Board The Federal Home Loan Bank Board (FHLBB) was a board created in 1932 that governed the Federal Home Loan Banks (FHLB or FHLBanks) also created by the act, the Federal Savings and Loan Insurance Corporation (FSLIC) and nationally-chartered thrifts ...

allowed federal S&Ls to originate Adjustable-rate mortgages in 1979 and in 1981 the Comptroller of the Currency extended the privilege to national banks. This regulation, enacted during times when fixed-rate loans at 17% were beyond the reach of many prospective home-owners, led to a series of innovations in adjustable-rate financing that contributed the easy credit that help fuel the housing bubble. Several authors single out the banking deregulation by the Gramm–Leach–Bliley Act as significant.

Nobel Prize The Nobel Prizes ( ; sv, Nobelpriset ; no, Nobelprisen ) are five separate prizes that, according to Alfred Nobel's will of 1895, are awarded to "those who, during the preceding year, have conferred the greatest benefit to humankind." Alfr ...

-winning economist

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was ...

has called Senator Phil Gramm "the father of the financial crisis" due to his sponsorship of the act but later revised his viewpoint saying repealing Glass-Steagall is "not what caused the financial crisis, which arose instead from ' shadow banks.

-winning

economist An economist is a professional and practitioner in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...

Joseph Stiglitz has also argued that GLB helped to create the crisis. An article in ''

The Nation ''The Nation'' is an American liberal biweekly magazine that covers political and cultural news, opinion, and analysis. It was founded on July 6, 1865, as a successor to William Lloyd Garrison's '' The Liberator'', an abolitionist newspaper t ...

'' has made the same argument. Economists Robert Ekelund and

Mark Thornton Mark Thornton (born June 7, 1960) is an American economist of the Austrian School. DiLorenzo, Thomas (2011-02-11My Associations with Liars, Bigots, and Murderers ''LewRockwell.com'' He has written on the topic of prohibition of drugs, the econo ...

have also criticized the Act as contributing to the

crisis A crisis ( : crises; : critical) is either any event or period that will (or might) lead to an unstable and dangerous situation affecting an individual, group, or all of society. Crises are negative changes in the human or environmental affair ...

. They state that while "in a world regulated by a

gold standard A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the l ...

, 100% reserve banking, and no

FDIC The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures credi ...

deposit insurance" the Financial Services Modernization Act would have made "perfect sense" as a legitimate act of deregulation, but under the present fiat monetary system it "amounts to

corporate welfare Corporate welfare is a phrase used to describe a government's bestowal of money grants, tax breaks, or other special favorable treatment for corporations. The definition of corporate welfare is sometimes restricted to direct government subsidie ...

for financial institutions and a

moral hazard In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk ...

that will make taxpayers pay dearly." Critics have also noted de facto deregulation through a shift in mortgage securitization market share from more highly regulated Government Sponsored Enterprises to less regulated investment banks.Michael Simkovic
''Competition and Crisis in Mortgage Securitization''
/ref> However, many economists, analysts and politicians reject the criticisms of the GLB legislation. Brad DeLong, a former advisor to President Clinton and economist at the University of California, Berkeley and

Tyler Cowen Tyler Cowen (; born January 21, 1962) is an American economist, columnist and blogger. He is a professor at George Mason University, where he holds the Holbert L. Harris chair in the economics department. He hosts the economics blog ''Marginal R ...

of George Mason University have both argued that the Gramm-Leach-Bliley Act softened the impact of the crisis by allowing for mergers and acquisitions of collapsing banks as the crisis unfolded in late 2008. "Alice M. Rivlin, who served as a deputy director of the Office of Management and Budget under Bill Clinton, said that GLB was a necessary piece of legislation because the separation of investment and commercial banking 'wasn't working very well.' Even Bill Clinton stated (in 2008): 'I don't see that signing that bill had anything to do with the current crisis.

Mandated loans

Republican Senator Marco Rubio has stated that the housing crisis was "created by reckless government policies." Republican appointee to the

Financial Crisis Inquiry Commission The Financial Crisis Inquiry Commission (FCIC) was a ten-member commission appointed by the leaders of the United States Congress with the goal of investigating the causes of the financial crisis of 2007–2008. The Commission has been nicknamed t ...

Peter J. Wallison and coauthor Edward Pinto believed that the housing bubble and crash was due to federal mandates to promote affordable housing. These were applied through the

Community Reinvestment Act The Community Reinvestment Act (CRA, P.L. 95-128, 91 Stat. 1147, title VIII of the Housing and Community Development Act of 1977, ''et seq.'') is a United States federal law designed to encourage commercial banks and savings associations to hel ...

and "

government sponsored entities A state-owned enterprise (SOE) is a government entity which is established or nationalised by the ''national government'' or ''provincial government'' by an executive order or an act of legislation in order to earn profit for the government ...

" (GSE's) "

" (Federal National Mortgage Association) and "

Freddie Mac The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia. Journalist Daniel Indiviglio argues the two GSE's played a major role, while not denying the importance of Wall Street and others in the private sector in creating the collapse. Did Fannie and Freddie Cause the Housing Bubble?
Daniel Indiviglio June 3, 2010 The Housing and Urban Development Act of 1992 established an affordable housing loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. Initially, the 1992 legislation required that 30 percent or more of Fannie's and Freddie's loan purchases be related to affordable housing. However, HUD was given the power to set future requirements. In 1995 HUD mandated that 40 percent of Fannie's and Freddie's loan purchases would have to support affordable housing. In 1996, HUD directed Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. This target was increased to 50% in 2000 and 52% in 2005. Under the Bush Administration HUD continued to pressure Fannie and Freddie to increase affordable housing purchases – to as high as 56 percent by the year 2008.Peter J. Wallison, "Dissent from the Majority Report of the Financial Crisis Inquiry Commission", (Washington, DC: American Enterprise Institute, January 2011), 61, www.aei.org. To satisfy these mandates, Fannie and Freddie eventually announced low-income and minority loan commitments totalling $5 trillion. Critics argue that, to meet these commitments, Fannie and Freddie promoted a loosening of lending standards - industry-wide. Regarding the Community Reinvestment Act (CRA), economist Stan Liebowitz wrote in the ''New York Post'' that a strengthening of the CRA in the 1990s encouraged a loosening of lending standards throughout the banking industry. He also charged the Federal Reserve with ignoring the negative impact of the CRA.Stan Liebowtiz

New York Post The ''New York Post'' (''NY Post'') is a conservative daily tabloid newspaper published in New York City. The ''Post'' also operates NYPost.com, the celebrity gossip site PageSix.com, and the entertainment site Decider.com. It was established ...

, February 5, 2008

American Enterprise Institute The American Enterprise Institute for Public Policy Research, known simply as the American Enterprise Institute (AEI), is a center-right Washington, D.C.–based think tank that researches government, politics, economics, and social welfare. A ...

Scholar Edward Pinto noted that, in 2008, Bank of America reported that its CRA portfolio, which constituted only 7 percent of its owned residential mortgages, was responsible for 29 percent of its losses. A Cleveland ''

Plain Dealer ''The Plain Dealer'' is the major newspaper of Cleveland, Ohio, United States. In fall 2019, it ranked 23rd in U.S. newspaper circulation, a significant drop since March 2013, when its circulation ranked 17th daily and 15th on Sunday. As of M ...

'' investigation found that "The City of Cleveland has aggravated its vexing foreclosure problems and has lost millions in tax dollars by helping people buy homes they could not afford." The newspaper added that these problem mortgages "typically came from local banks fulfilling federal requirements to lend money in poorer neighbourhoods." Others argue that "pretty much all the evidence on the housing crisis shows" that Fannie Mae, Freddie Mac, the (CRA) and their affordability goals were not a major reason for the bubble and crash. Law professor David Min argues that view (blaming GSE's and CRA) "is clearly contradicted by the facts", namely that * Parallel bubble-bust cycles occurred outside of the residential housing markets (for example, in commercial real estate and consumer credit). * Parallel financial crises struck other countries, which did not have analogous affordable housing policies * The U.S. government’s market share of home mortgages was actually declining precipitously during the housing bubble of the 2000s. However, according to Peter J. Wallison, other developed countries with "large bubbles during the 1997–2007 period" had "far lower ... losses associated with mortgage delinquencies and defaults" because (according to Wallison), these countries' bubbles were not supported by a huge number of government mandated substandard loans – generally with low or no downpayments" as was the case in the US. Other analysis calls into question the validity of comparing the residential loan crisis to the commercial loan crisis. After researching the default of commercial loans during the financial crisis, Xudong An and Anthony B. Sanders reported (in December 2010): "We find limited evidence that substantial deterioration in CMBS ommercial mortgage-backed securitiesloan underwriting occurred prior to the crisis." Other analysts support the contention that the crisis in commercial real estate and related lending took place ''after'' the crisis in residential real estate. Business journalist Kimberly Amadeo reports: "The first signs of decline in residential real estate occurred in 2006. Three years later, commercial real estate started feeling the effects. Denice A. Gierach, a real estate attorney and CPA, wrote:

most of the commercial real estate loans were good loans destroyed by a really bad economy. In other words, the borrowers did not cause the loans to go bad, it was the economy.

In their book on the financial crisis Business journalists Bethany McLean and

Joe Nocera Joseph Nocera (born May 6, 1952) is an American business journalist, and author. He has written for The New York Times since April 2005, writing for the Op-Ed page from 2011 to 2015. He was also an opinion columnist for Bloomberg Opinion. Early ...

argue that the charges against Fannie and Freddie are "completely upside down; Fannie and Freddie raced to get into subprime mortgages because they feared being left behind by their nongovernment competitors." Most early estimates showed that the subprime mortgage boom and the subsequent crash were very much concentrated in the private market, not the public market of Fannie Mae and Freddie Mac. According to an estimate made by the Federal Reserve in 2008, more than 84 percent of the subprime mortgages came from private lending institutions in 2006. The share of subprime loans insured by Fannie Mae and Freddie Mac also decreased as the bubble got bigger (from a high of insuring 48 percent to insuring 24 percent of all subprime loans in 2006). To make its estimate, the Federal Reserve did not directly analyze the characteristics of the loans (such as downpayment sizes); rather, it assumed that loans carrying interest rates 3% or more higher than normal rates were subprime and loans with lower interest rates were prime. Critics dispute the Federal Reserve's use of interest rates to distinguish prime from subprime loans. They say that subprime loan estimates based on use of the high-interest-rate proxy are distorted because government programs generally promote low-interest rate loans – even when the loans are to borrowers who are clearly subprime.Joseph Fried, Who Really Drove the Economy Into the Ditch? (New York, NY: Algora Publishing, 2012), 141. According to Min, while Fannie and Freddie did buy high-risk mortgage-backed securities,

they did not buy enough of them to be blamed for the mortgage crisis. Highly respected analysts who have looked at these data in much greater detail than Wallison, Pinto, or myself, including the nonpartisan Government Accountability Office, the Harvard Joint Center for Housing Studies, the Financial Crisis Inquiry Commission majority, the Federal Housing Finance Agency, and virtually all academics, including the University of North Carolina, Glaeser et al. at Harvard, and the St. Louis Federal Reserve, have all rejected the Wallison/Pinto argument that federal affordable housing policies were responsible for the proliferation of actual high-risk mortgages over the past decade.

Min's contention that Fannie and Freddie did not buy a significant amount of high-risk mortgage backed securities must be evaluated in light of subsequent SEC security fraud charges brought against executives of Fannie Mae and Freddie Mac in December 2011. Significantly, the SEC alleged (and still maintains) that Fannie Mae and Freddie Mac reported as subprime and substandard ''less than 10 percent'' of their actual subprime and substandard loans. In other words, the substandard loans held in the GSE portfolios may have been 10 times greater than originally reported. According to Peter Wallison of the

, that would make the SEC's estimate of GSE substandard loans about $2 trillion - significantly higher than Edward Pinto's estimate. The Federal Reserve also estimated that only six percent of higher-priced loans were extended by

-covered lenders to lower-income borrowers or CRA neighborhoods. (As it did with respect to GSE loans, the Federal Reserve assumed that all CRA loans were prime unless they carried interest rates 3% or more above the normal rate, an assumption disputed by others.) In a 2008 speech, Federal Reserve Governor

Randall Kroszner Randall S. Kroszner (born June 22, 1962) is an American economist who served as a member of the Federal Reserve Board of Governors from 2006 to 2009. Kroszner chaired Fed's board Committee on Supervision and Regulation of Banking Institutions du ...

, argued that the CRA could not be responsible for the subprime mortgage crisis, stating that

"first, only a small portion of subprime mortgage originations are related to the CRA. Second, CRA-related loans appear to perform comparably to other types of subprime loans. Taken together… we believe that the available evidence runs counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis"

Others, such as

Federal Deposit Insurance Corporation The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures cr ...

Chairman Sheila Bair, and Ellen Seidman of the

New America Foundation New America, formerly the New America Foundation, is a think tank in the United States founded in 1999. It focuses on a range of public policy issues, including national security studies, technology, asset building, health, gender, energy, educa ...

also argue that the CRA was not responsible for the crisis. The CRA also only affected one out of the top 25 subprime lenders. According to several economists, Community Reinvestment Act loans outperformed other "subprime" mortgages, and GSE mortgages performed better than private label securitizations. Nonetheless, economists at the

National Bureau of Economic Research The National Bureau of Economic Research (NBER) is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic c ...

concluded that banks undergoing CRA-related regulatory exams took additional mortgage lending risk. The authors of a study entitled "Did the Community Reinvestment Act Lead to Risky Lending?" compared "the lending behavior of banks undergoing CRA exams within a given census tract in a given month (the treatment group) to the behavior of banks operating in the same census tract-month that did not face these exams (the control group). This comparison clearly indicates that adherence to the CRA led to riskier lending by banks." They concluded: "The evidence shows that around CRA examinations, when incentives to conform to CRA standards are particularly high, banks not only increase lending rates but also appear to originate loans that are markedly riskier." Loan delinquency averaged 15% higher in the treatment group than the control group one year after mortgage origination.

Historically low interest rates

According to some, such as

John B. Taylor John Brian Taylor (born December 8, 1946) is the Mary and Robert Raymond Professor of Economics at Stanford University, and the George P. Shultz Senior Fellow in Economics at Stanford University's Hoover Institution. He taught at Columbia Univer ...

and Thomas M. Hoenig, "excessive risk-taking and the housing boom" were brought on by the Federal Reserve holding "interest rates too low for too long". In the wake of the

dot-com crash The dot-com bubble (dot-com boom, tech bubble, or the Internet bubble) was a stock market bubble in the late 1990s, a period of massive growth in the use and adoption of the Internet. Between 1995 and its peak in March 2000, the Nasdaq Compo ...

and the subsequent 2001–2002 recession the Federal Reserve dramatically lowered interest rates to historically low levels, from about 6.5% to just 1%. This spurred easy credit for banks to make loans. By 2006 the rates had moved up to 5.25% which lowered the demand and increased the monthly payments for adjustable rate mortgages. The resulting foreclosures increased supply, dropping housing prices further. Former Federal Reserve Board Chairman Alan Greenspan admitted that the housing bubble was "fundamentally engendered by the decline in real long-term interest rates." Mortgages had been bundled together and sold on Wall Street to investors and other countries looking for a higher return than the 1% offered by Federal Reserve. The percentage of risky mortgages was increased while rating companies claimed they were all top-rated. Instead of the limited regions suffering the housing drop, it was felt around the world. The Congressmen who had pushed to create subprime loans now cited Wall Street and their rating companies for misleading these investors. Federal funds effective rate 1954 to present

Federal funds effective rate 1954 to present

In the United States, mortgage rates are typically set in relation to 10-year

treasury bond United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...

yields, which, in turn, are affected by Federal Funds rates. The Federal Reserve acknowledges the connection between lower interest rates, higher home values, and the increased liquidity the higher home values bring to the overall economy. A Federal Reserve report reads: For this reason, some have criticized then Fed Chairman Alan Greenspan for "engineering" the housing bubble, saying, e.g., "It was the Federal Reserve-engineered decline in rates that inflated the housing bubble." Between 2000 and 2003, the interest rate on 30-year fixed-rate mortgages fell 2.5 percentage points (from 8% to all-time historical low of about 5.5%). The interest rate on one-year

adjustable rate mortgage A variable-rate mortgage, adjustable-rate mortgage (ARM), or tracker mortgage is a mortgage loan with the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets.Wie ...

s (1/1 ARMs) fell 3 percentage points (from about 7% to about 4%). Richard Fisher, president of the Dallas Fed, said in 2006 that the Fed's low interest-rate policies unintentionally prompted speculation in the housing market, and that the subsequent "substantial correction sinflicting real costs to millions of homeowners." A drop in mortgage interest rates reduces the cost of borrowing and should logically result in an increase in prices in a market where most people borrow money to purchase a home (for instance, in the United States), so that average payments remain constant. If one assumes that the housing market is efficient, the expected change in housing prices (relative to interest rates) can be computed mathematically. The calculation in the sidebox shows that a 1 percentage point change in interest rates would theoretically affect home prices by about 10% (given 2005 rates on fixed-rate mortgages). This represents a 10-to-1 multiplier between percentage point changes in interest rates and percentage change in home prices. For interest-only mortgages (at 2005 rates), this yields about a 16% change in principal for a 1% change in interest rates at current rates. Therefore, the 2% drop in long-term interest rates can account for about a 10 × 2% = 20% rise in home prices if every buyer is using a fixed-rate mortgage (FRM), or about 16 × 3% ≈ 50% if every buyer is using an adjustable rate mortgage (ARM) whose interest rates dropped 3%.

Robert Shiller Robert James Shiller (born March 29, 1946) is an American economist, academic, and author. As of 2019, he serves as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management's International Center for ...

shows that the inflation adjusted U.S. home price increase has been about 45% during this period, an increase in valuations that is approximately consistent with most buyers financing their purchases using ARMs. In areas of the United States believed to have a housing bubble, price increases have far exceeded the 50% that might be explained by the cost of borrowing using ARMs. For example, in

San Diego San Diego ( , ; ) is a city on the Pacific Ocean coast of Southern California located immediately adjacent to the Mexico–United States border. With a 2020 population of 1,386,932, it is the eighth most populous city in the United State ...

area, average mortgage payments grew 50% between 2001 and 2004. When interest rates rise, a reasonable question is how much house prices will fall, and what effect this will have on those holding

negative equity Negative equity is a deficit of owner's equity, occurring when the value of an asset used to secure a loan is less than the outstanding balance on the loan. In the United States, assets (particularly real estate, whose loans are mortgages) with ne ...

, as well as on the U.S. economy in general. The salient question is whether interest rates are a determining factor in specific markets where there is high sensitivity to housing affordability. (Thomas Sowell points out that these markets where there is high sensitivity to housing affordability are created by laws that restrict land use and thus its supply. In areas like Houston which has no zoning laws the Fed rate had no effect.)

Return to higher rates

Between 2004 and 2006, the Fed raised interest rates 17 times, increasing them from 1% to 5.25%, before pausing. The Fed paused raising interest rates because of the concern that an accelerating downturn in the housing market could undermine the overall economy, just as the crash of the

dot-com bubble The dot-com bubble (dot-com boom, tech bubble, or the Internet bubble) was a stock market bubble in the late 1990s, a period of massive growth in the use and adoption of the Internet. Between 1995 and its peak in March 2000, the Nasdaq Compo ...

in 2000 contributed to the subsequent recession. However,

New York University New York University (NYU) is a private research university in New York City. Chartered in 1831 by the New York State Legislature, NYU was founded by a group of New Yorkers led by then- Secretary of the Treasury Albert Gallatin. In 1832, th ...

economist

Nouriel Roubini Nouriel Roubini (born March 9 1958) is a Turkish-born Iranian-American economist. He is Professor Emeritus (2021–present) and was Professor of Economics (1995–2021) at the Stern School of Business, New York University, and also chairman of Ro ...

asserted that "The Fed should have tightened earlier to avoid a festering of the housing bubble early on." There was a great debate as to whether or not the Fed would lower rates in late 2007. The majority of economists expected the Fed to maintain the Fed funds rate at 5.25 percent through 2008; however, on September 18, it lowered the rate to 4.75 percent.

Regions affected

Home price appreciation has been non-uniform to such an extent that some economists, including former Fed Chairman

, arguedthat the United States was not experiencing a nationwide housing bubble ''per se'', but a number of local bubbles. However, in 2007 Greenspan admitted that there was in fact a bubble in the US housing market, and that "all the froth bubbles add up to an aggregate bubble." Despite greatly relaxed lending standards and low interest rates, many regions of the country saw very little growth during the "bubble period". Out of 20 largest metropolitan areas tracked by the S&P/Case-Shiller

house price index A house price index (HPI) measures the price changes of residential housing as a percentage change from some specific start date (which has an HPI of 100). Methodologies commonly used to calculate an HPI are hedonic regression (HR), simple moving ...

, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001–2006. During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington DC) appreciated by more than 80%. Somewhat paradoxically, as the housing bubble deflates some metropolitan areas (such as Denver and Atlanta) have been experiencing high foreclosure rates, even though they did not see much house appreciation in the first place and therefore did not appear to be contributing to the national bubble. This was also true of some cities in the

Rust Belt The Rust Belt is a region of the United States that experienced industrial decline starting in the 1950s. The U.S. manufacturing sector as a percentage of the U.S. GDP peaked in 1953 and has been in decline since, impacting certain regions an ...

such as

Detroit Detroit ( , ; , ) is the largest city in the U.S. state of Michigan. It is also the largest U.S. city on the United States–Canada border, and the seat of government of Wayne County. The City of Detroit had a population of 639,111 at t ...

and

Cleveland Cleveland ( ), officially the City of Cleveland, is a city in the U.S. state of Ohio and the county seat of Cuyahoga County. Located in the northeastern part of the state, it is situated along the southern shore of Lake Erie, across the U.S. ...

, where weak local economies had produced little house price appreciation early in the decade but still saw declining values and increased foreclosures in 2007. As of January 2009 California, Michigan, Ohio and Florida were the states with the highest foreclosure rates.

'Mania' for home ownership

Americans' love of their homes is widely known and acknowledged; however, many believe that enthusiasm for home ownership is currently high even by American standards, calling the real estate market "frothy", "speculative madness", and a "mania". Many observers have commented on this phenomenon—as evidenced by the cover of the June 13, 2005 issue of ''

Time Time is the continued sequence of existence and events that occurs in an apparently irreversible succession from the past, through the present, into the future. It is a component quantity of various measurements used to sequence events, ...

'' magazine (itself taken as a sign of the bubble's peak )—but as a 2007 article in ''

Forbes ''Forbes'' () is an American business magazine owned by Integrated Whale Media Investments and the Forbes family. Published eight times a year, it features articles on finance, industry, investing, and marketing topics. ''Forbes'' also r ...

'' warns, "to realize that America's mania for home-buying is out of all proportion to sober reality, one needs to look no further than the current subprime lending mess ... As interest rates—and mortgage payments—have started to climb, many of these new owners are having difficulty making ends meet ... Those borrowers are much worse off than before they bought." The boom in housing has also created a boom in the

real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more general ...

profession; for example, California has a record half-million real estate licencees—one for every 52 adults living in the state, up 57% in the last five years. The overall U.S. homeownership rate increased from 64 percent in 1994 (about where it was since 1980) to a peak in 2004 with an all-time high of 69.2 percent. Bush's 2004 campaign slogan "the ownership society" indicates the strong preference and societal influence of Americans to own the homes they live in, as opposed to renting. However, in many parts of the United States, rent does not cover mortgage costs; the national median mortgage payment is $1,687 per month, nearly twice the median rent payment of $868 per month, although this ratio can vary significantly from market to market. Suspicious Activity Reports pertaining to

mortgage fraud Mortgage fraud refers to an intentional misstatement, misrepresentation, or omission of information relied upon by an underwriter or lender to fund, purchase, or insure a loan secured by real property. Criminal offenses may be prosecuted in eith ...

increased by 1,411 percent between 1997 and 2005. Both borrowers seeking to obtain homes they could not otherwise afford, and industry insiders seeking monetary gain, were implicated.

Belief that housing is a good investment

Among Americans, home ownership is widely accepted as preferable to renting in many cases, especially when the ownership term is expected to be at least five years. This is partly because the fraction of a fixed-rate

mortgage A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...

used to pay down the principal builds equity for the homeowner over time, while the interest portion of the loan payments qualifies for a tax break, whereas, except for the personal tax deduction often available to renters but not to homeowners, money spent on rent does neither. However, when considered as an investment, that is, an

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...

that is expected to grow in value over time, as opposed to the utility of shelter that home ownership provides, housing is not a risk-free investment. The popular notion that, unlike stocks, homes do not fall in value is believed to have contributed to the mania for purchasing homes. Stock prices are reported in real time, which means investors witness the volatility. However, homes are usually valued yearly or less often, thereby smoothing out perceptions of volatility. This assertion that property prices rise has been true for the United States as a whole since the Great Depression, and appears to be encouraged by the real estate industry. However, housing prices can move both up and down in local markets, as evidenced by the relatively recent price history in locations such as New York,

Los Angeles Los Angeles ( ; es, Los Ángeles, link=no , ), often referred to by its initials L.A., is the List of municipalities in California, largest city in the U.S. state, state of California and the List of United States cities by population, sec ...

Boston Boston (), officially the City of Boston, is the state capital and most populous city of the Commonwealth of Massachusetts, as well as the cultural and financial center of the New England region of the United States. It is the 24th- mo ...

, Japan,

Seoul Seoul (; ; ), officially known as the Seoul Special City, is the capital and largest metropolis of South Korea.Before 1972, Seoul was the ''de jure'' capital of the Democratic People's Republic of Korea (North Korea) as stated iArticle 103 of ...

, Sydney, and

Hong Kong Hong Kong ( (US) or (UK); , ), officially the Hong Kong Special Administrative Region of the People's Republic of China (abbr. Hong Kong SAR or HKSAR), is a city and special administrative region of China on the eastern Pearl River Delta i ...

; large trends of up and down price fluctuations can be seen in many U.S. cities (see graph). Since 2005, the year-over-year median sale prices (inflation-adjusted) of single family homes in

Massachusetts Massachusetts (Massachusett: ''Muhsachuweesut Massachusett_writing_systems.html" ;"title="nowiki/> məhswatʃəwiːsət.html" ;"title="Massachusett writing systems">məhswatʃəwiːsət">Massachusett writing systems">məhswatʃəwiːsət'' En ...

fell over 10% in 2006. Economist David Lereah formerly of the National Association of Realtors (NAR) said in August 2006 that "he expects home prices to come down 5% nationally, more in some markets, less in others." Commenting in August 2005 on the perceived low risk of housing as an investment vehicle, Alan Greenspan said, "history has not dealt kindly with the aftermath of protracted periods of low risk premiums." Compounding the popular expectation that home prices do not fall, it is also widely believed that home values will yield average or better-than-average returns as investments. The investment motive for purchasing homes should not be conflated with the necessity of shelter that housing provides; an economic comparison of the relative costs of owning versus renting the equivalent utility of shelter can be made separately (see boxed text). Over the holding periods of decades, inflation-adjusted house prices have increased less than 1% per year. Plot of inflation-adjusted home price appreciation in several U.S. cities, 1990–2005:

shows that over long periods, inflation adjusted U.S. home prices increased 0.4% per year from 1890 to 2004, and 0.7% per year from 1940 to 2004. Piet Eichholtz also showed in what has become known as the Herengracht house index, comparable results for housing prices on a single street in

Amsterdam Amsterdam ( , , , lit. ''The Dam on the River Amstel'') is the capital and most populous city of the Netherlands, with The Hague being the seat of government. It has a population of 907,976 within the city proper, 1,558,755 in the urban ar ...

(the site of the fabled

tulip mania Tulip mania ( nl, tulpenmanie) was a period during the Dutch Golden Age when contract prices for some bulbs of the recently introduced and fashionable tulip reached extraordinarily high levels. The major acceleration started in 1634 and then d ...

, and where the housing supply is notably limited) over a 350 year period. Such meager returns are dwarfed by investments in the stock and

bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemica ...

markets; although, these investments are not heavily leveraged by fair interest loans. If historic trends hold, it is reasonable to expect home prices to only slightly beat inflation over the long term. Furthermore, one way to assess the quality of any investment is to compute its price-to-earnings (P/E) ratio, which for houses can be defined as the price of the house divided by the potential annual rental income, minus expenses including property taxes, maintenance, insurance, and condominium fees. For many locations, this computation yields a P/E ratio of about 30–40, which is considered by economists to be high for both the housing and the stock markets; historical price-to-rent ratios are 11–12. For comparison, just before the

the P/E ratio of the

S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...

was 45, while in 2005–2007 around 17. In a 2007 article comparing the cost and risks of renting to buying using
buy vs. rent calculator
''

The New York Times ''The New York Times'' (''the Times'', ''NYT'', or the Gray Lady) is a daily newspaper based in New York City with a worldwide readership reported in 2020 to comprise a declining 840,000 paid print subscribers, and a growing 6 million paid d ...

'' concluded, A 2007 ''

'' article titled "Don't Buy That House" invokes similar arguments and concludes that for now, "resist the pressure

o buy O, or o, is the fifteenth letter and the fourth vowel letter in the Latin alphabet, used in the modern English alphabet, the alphabets of other western European languages and others worldwide. Its name in English is ''o'' (pronounced ), pl ...

There may be no place like home, but there's no reason you can't rent it."

Promotion in the media

In late 2005 and into 2006, there were an abundance of television programs promoting real estate investment and

flipping Flipping is a term used to describe purchasing a revenue-generating asset and quickly reselling (or "flipping") it for profit. Within the real estate industry, the term is used by investors to describe the process of buying, rehabbing, and sel ...

. In addition to the numerous television shows, book stores in cities throughout the United States could be seen showing large displays of books touting real-estate investment, such as NAR chief economist David Lereah's book ''Are You Missing the Real Estate Boom?'', subtitled ''Why Home Values and Other Real Estate Investments Will Climb Through The End of The Decade - And How to Profit From Them'', published in February 2005. One year later, Lereah retitled his book ''Why the Real Estate Boom Will Not Bust - And How You Can Profit from It''. However, following

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

chairman Ben Bernanke's comments on the "downturn of the housing market" in August 2006, Lereah said in an

NBC The National Broadcasting Company (NBC) is an American English-language commercial broadcast television and radio network. The flagship property of the NBC Entertainment division of NBCUniversal, a division of Comcast, its headquarters are l ...

interview that "we've had a boom marketplace: you've got to correct because booms cannot sustain itself forever ." The video of the report is available a
an entry of 2006-08-19
on the blog ''Housing Panic''. Commenting on the phenomenon of shifting NAR accounts of the national housing market (see David Lereah's comments), the

Motley Fool The Motley Fool is a private financial and investing advice company based in Alexandria, Virginia. It was founded in July 1993 by co-chairmen and brothers David Gardner and Tom Gardner, and Erik Rydholm, who has since left the company. The compa ...

reported, "There's nothing funnier or more satisfying ... than watching the National Association of Realtors (NAR) change its tune these days. ... the NAR is full of it and will spin the numbers any way it can to keep up the pleasant fiction that all is well." Upon leaving the NAR in May 2007, Lereah explained to

Robert Siegel Robert Charles Siegel (born June 26, 1947) is an American retired radio journalist. He was one of the co-hosts of the National Public Radio evening news broadcast ''All Things Considered'' from 1987 until his retirement in January 2018. Early ...

National Public Radio National Public Radio (NPR, stylized in all lowercase) is an American privately and state funded nonprofit media organization headquartered in Washington, D.C., with its NPR West headquarters in Culver City, California. It differs from other ...

that using the word "boom" in the title was actually his publisher's idea, and "a poor choice of titles".

Speculative fever

US derivatives and US wealth vs total world wealth 1995-2007

The graph above shows the total notional value of derivatives relative to US wealth measures. It is important to note for the casual observer that, in many cases, notional values of derivatives carry little meaning. Often the parties cannot easily agree on terms to close a derivative contract. The common solution has been to create an equal and opposite contract, often with a different party, in order to net payments ( Derivatives market#Netting), thus eliminating all but the counterparty risk of the contract, but doubling the nominal value of outstanding contracts. As median home prices began to rise dramatically in 2000–2001 following the fall in interest rates, speculative purchases of homes also increased. '' Fortune'' magazine's article on housing speculation in 2005 said, "America was awash in a stark, raving frenzy that looked every bit as crazy as dot-com stocks." In a 2006 interview in ''

BusinessWeek ''Bloomberg Businessweek'', previously known as ''BusinessWeek'', is an American weekly business magazine published fifty times a year. Since 2009, the magazine is owned by New York City-based Bloomberg L.P. The magazine debuted in New York City ...

'' magazine, Yale economist

said of the impact of speculators on long term valuations, "I worry about a big fall because prices today are being supported by a speculative fever", and former NAR chief economist David Lereah said in 2005 that " ere's a speculative element in home buying now."^{roken footnote/sup> Speculation in some local markets has been greater than others, and any correction in valuations is expected to be strongly related to the percentage amount of speculative purchases. In the same ''BusinessWeek

''Bloomberg Businessweek'', previously known as ''BusinessWeek'', is an American weekly business magazine published fifty times a year. Since 2009, the magazine is owned by New York City-based Bloomberg L.P. The magazine debuted in New York City ...
'' interview, Angelo Mozilo, CEO of mortgage lender Countrywide Financial

Countrywide is one of the UK's largest integrated property services group including residential property surveying, a collaboration of estate agents, and corporate services. It employs circa 8,500 personnel nationwide, working across 650+ estat ...
, said in March 2006:
The chief economist for the National Association of Home Builders

The National Association of Home Builders (NAHB) is one of the largest trade associations in the United States, representing the interests of home builders, developers, contractors, and associated businesses. NAHB is headquartered in Washington, ...
, David Seiders, said that California, Las Vegas, Florida and the Washington, D.C., area "have the largest potential for a price slowdown" because the rising prices in those markets were fed by speculators who bought homes intending to "flip" or sell them for a quick profit.
Dallas Fed president Richard Fisher said in 2006 that the Fed held its target rate at 1 percent "longer than it should have been" and unintentionally prompted speculation in the housing market.

Various real estate investment advisors openly advocated the use of no money down property flipping, which led to the demise of many speculators who followed this strategy such as Casey Serin

Casey Konstantin Serin (born September 10, 1982, legally renamed Casey Constantine in April 2016) is an Uzbekistan-born American blogger, mortgage broker, and real estate investor. In a newspaper article, ''USA Today'' called him the "poster chil ...
.

According to a 2020 study, the main driver behind shifts in house prices were shifts in beliefs, rather than a shift in underlying credit conditions.

Buying and selling above normal multiples

Home prices, as a multiple of annual rent, have been 15 since World War II. In the bubble, prices reached a multiple of 26. In 2008, prices had fallen to a multiple of 22.

In some areas houses were selling at multiples of replacement costs, especially when prices were correctly adjusted for depreciation. Cost per square foot indexes still show wide variability from city to city, therefore it may be that new houses can be built more cheaply in some areas than asking prices for existing homes.

Possible factors of this variation from city to city are housing supply constraints, both regulatory and geographical. Regulatory constraints such as urban growth boundaries serve to reduce the amount of developable land and thus increase prices for new housing construction. Geographic constraints (water bodies, wetlands, and slopes) cannot be ignored either. It is debatable which type of constraint contributes more to price fluctuations. Some argue that the latter, by inherently increasing the value of land in a defined area (because the amount of usable land is less), give homeowners and developers incentive to support regulations to further protect the value of their property.

In this case, geographical constraints beget regulatory action. To the contrary, others will argue that geographic constraints are only a secondary factor, pointing to the more discernable effects that urban growth boundaries have on housing prices in such places as Portland, OR. Despite the presence of geographic constraints in the surrounding Portland area, their current urban growth boundary
An urban growth boundary, or UGB, is a regional boundary, set in an attempt to control urban sprawl by, in its simplest form, mandating that the area inside the boundary be used for urban development and the area outside be preserved in its natural ...
does not encompass those areas. Therefore, one would argue, such geographic constraints are a non issue.

Dot-com bubble collapse

Yale

Yale University is a private research university in New Haven, Connecticut. Established in 1701 as the Collegiate School, it is the third-oldest institution of higher education in the United States and among the most prestigious in the wor ...
economist Robert Shiller

Robert James Shiller (born March 29, 1946) is an American economist, academic, and author. As of 2019, he serves as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management's International Center for ...
argues that the 2000 stock market crash displaced "irrational exuberance" from the fallen stock market to residential real estate: "Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed."

The crash of the dot-com and technology sectors in 2000 led to a (approximately) 70% drop in the NASDAQ composite index. Shiller and several other economists have argued this resulted in many people taking their money out of the stock market and purchasing real estate

Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more general ...
, believing it to be a more reliable investment.

Risky mortgage products and lax lending standards

Excessive consumer housing debt was in turn caused by the mortgage-backed security

A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment b ...
, credit default swap

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against som ...
, and collateralized debt obligation

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Le ...
sub-sectors of the finance industry

Financial services are the economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, credit-card companies, insurance companies, accountancy companies, ...
, which were offering irrationally low interest rates and irrationally high levels of approval to subprime mortgage

In finance, subprime lending (also referred to as near-prime, subpar, non-prime, and second-chance lending) is the provision of loans to people in the United States who may have difficulty maintaining the repayment schedule. Historically, subpri ...
consumers because they were calculating aggregate risk using gaussian copula

In probability theory and statistics, a copula is a multivariate cumulative distribution function for which the marginal probability distribution of each variable is uniform on the interval , 1 Copulas are used to describe/model the de ...
formulas that strictly assumed the independence of individual component mortgages, when in fact the credit-worthiness almost every new subprime mortgage was highly correlated with that of any other because of linkages through consumer spending levels which fell sharply when property values began to fall during the initial wave of mortgage defaults. Debt consumers were acting in their rational self-interest, because they were unable to audit the finance industry's opaque faulty risk pricing methodology.

Expansion of subprime lending

Low interest rates, high home prices, and flipping

Flipping is a term used to describe purchasing a revenue-generating asset and quickly reselling (or "flipping") it for profit.

Within the real estate industry, the term is used by investors to describe the process of buying, rehabbing, and sel ...
(or reselling homes to make a profit), effectively created an almost risk-free environment for lenders because risky or defaulted loans could be paid back by flipping homes.

Private lenders pushed subprime mortgages to capitalize on this, aided by greater market power for mortgage originators and less market power for mortgage securitizers. Subprime mortgages amounted to $35 billion (5% of total originations) in 1994, 9% in 1996, $160 billion (13%) in 1999, and $600 billion (20%) in 2006.

Risky products

The recent use of subprime mortgages, adjustable rate mortgage
A variable-rate mortgage, adjustable-rate mortgage (ARM), or tracker mortgage is a mortgage loan with the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets.Wie ...
s, interest-only mortgages, Credit default swaps

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against so ...
, Collateralized debt obligations

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Lepke ...
, Frozen credit markets and stated income loans (a subset of "Alt-A An Alt-A mortgage, short for Alternative A-paper, is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or "prime", and less risky than " subprime," the riskiest category. For these reasons, as well as in some c ...
" loans, where the borrower did not have to provide documentation to substantiate the income stated on the application; these loans were also called "no doc" (no documentation) loans and, somewhat pejoratively, as "liar loans") to finance home purchases described above have raised concerns about the quality of these loans should interest rates rise again or the borrower is unable to pay the mortgage.

In many areas, particularly in those with most appreciation, non-standard loans went from almost unheard of to prevalent. For example, 80% of all mortgages initiated in San Diego region in 2004 were adjustable-rate, and 47% were interest only.

In 1995, Fannie Mae

The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the N ...
and Freddie Mac

The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia.
According to a Government Accountability Office study, there are higher default and foreclosure rates for these mortgages. The study also showed that sellers inflated home prices to recoup their contributions to the nonprofits.

On May 4, 2006, the IRS ruled that such plans are no longer eligible for non-profit status due to the circular nature of the cash flow, in which the seller pays the charity a "fee" after closing. On October 31, 2007, the Department of
Housing and Urban Development adopted new regulations banning so-called "seller-funded" downpayment programs. Most must cease providing grants on FHA loans immediately; one can operate until March 31, 2008.

Mortgage standards became lax because of a moral hazard

In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk ...
, where each link in the mortgage chain collected profits while believing it was passing on risk. Mortgage denial rates for conventional home purchase loans, reported under the Home Mortgage Disclosure Act, have dropped noticeably, from 29 percent in 1998, to 14 percent in 2002 and 2003. Traditional gatekeepers such as mortgage securitizers and credit rating agencies lost their ability to maintain high standards because of competitive pressures.

Mortgage risks were underestimated by every institution in the chain from originator to investor by underweighting the possibility of falling housing prices given historical trends of rising prices. These authors argue that misplaced confidence in innovation and excessive optimism led to miscalculations by both public and private institutions.

In March 2007, the United States' subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates, with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. '' Harper's Magazine'' warned of the danger of rising interest rates for recent homebuyers holding such mortgages, as well as the U.S. economy as a whole: "The problem sthat prices are falling even as the buyers' total mortgage remains the same or even increases. ... Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the "real" economy, drive down those already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse."

Factors that could contribute to rising rates are the U.S. national debt, inflationary pressure caused by such factors as increased fuel and housing costs, and changes in foreign investments in the U.S. economy. The Fed raised rates 17 times, increasing them from 1% to 5.25%, between 2004 and 2006. ''BusinessWeek

''Bloomberg Businessweek'', previously known as ''BusinessWeek'', is an American weekly business magazine published fifty times a year. Since 2009, the magazine is owned by New York City-based Bloomberg L.P. The magazine debuted in New York City ...
'' magazine called the option ARM (which might permit a minimum monthly payment less than an interest-only payment) "the riskiest and most complicated home loan product ever created" and warned that over one million borrowers took out $466 billion in option ARMs in 2004 through the second quarter of 2006, citing concerns that these financial products could hurt individual borrowers the most and "worsen the ousingbust".

To address the problems arising from "liar loans", the Internal Revenue Service updated an income verification tool used by lenders to make confirmation of borrower's claimed income faster and easier. In April 2007, financial problems similar to the subprime mortgages began to appear with Alt-A loans made to homeowners who were thought to be less risky; the delinquency rate for Alt-A mortgages rose in 2007. The manager of the world's largest bond fund PIMCO, warned in June 2007 that the subprime mortgage crisis was not an isolated event and will eventually take a toll on the economy and whose ultimate impact will be on the impaired prices of homes.

See also

* Resolution Trust Corporation

The Resolution Trust Corporation (RTC) was a U.S. government-owned asset management company run by Lewis William Seidman and charged with liquidating assets, primarily real estate-related assets such as mortgage loans, that had been assets ...

* Savings and loan crisis

References

{{Financial bubbles

United States housing bubble

The 2000s United States housing bubble was a real-estate bubble affecting over half of the U.S. states. It was the impetus for the subprime mortgage crisis. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and reac ...

United States housing bubble
Urban politics in the United States

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