Analysis of Housing Bubble Crisis and Monetary Policy

The assignment provides an analysis of the US housing bubble crisis, discussing various perspectives on its causes, including low interest rates provided by Federal reserves. It concludes that monetary policy has a direct impact on national and global economies, with slight changes affecting outcomes. The summary covers key points from articles and journals referenced in the report.

Critically assess the effects of
monetary policy on housing
bubbles

Table of Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................6

INTRODUCTION
Asset price bubble id one of the major crises which can be faced by economy of a
country and sometimes it leads to effect global economy. In the history not all bubbles are same
but the housing bubble which was faced in the US in year 2008-2009. The crises were
associated with the housing market where more than one bubble were creates such as equity
bubble. In this report a detailed discussion related with housing bumble created in Us economy is
presented, as this effected not only economy in the US but over all global economy was effected
ans that too in worse manner. In the present report the factors that lead to creation of the bubbles
and its effect on economy is presented.
MAIN BODY
Housing bubble:
This can be explained as a period of time which is faced b real estate industry where the
prices of the houses grow to above the average limit. In this case there is limit supply and high
demand of house and property and this situation goes in other direction rather than being turned
to a positive one these create a situation of creation of bubble where there is a high demand and
either less to no supply of property at all (What Caused the Housing Bubble, 2018) . When the
situation get stretched to long the bubble gets busted and results in a sharp fall in property with a
burst in the bubble price fall down to the lowest still there is no demand and high supply.
It’s hard to determine a housing bubble until it pops. The moment comes when an addition of
housing supply tumble over deprecatory demand. With a consultant in growth in demand this
situation will come sooner or later.
Monetary policy:
This can be defined as the central bank of nation which regulated and mages the liquidity
to create the economic growth. Liquidity means how much money is in the money supply which
includes credit, cash, and mutual funds in money market (Cheng, Raina and Xiong, 2014|) . The
main objectives of having monetary policy is to manage the inflation and to reduction of
unemployment. In the US central bank is the Fed Reserve which looks out formulation of all
monetary policies for the US economy. The
A major crisis:
In 2008, a major crisis was suffered by the Us economy and with a burst in the housing
bubble, problem of recession aroused and this effected the whole world as US the is most
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powerful economy in the world (The Fed and the Crisis, 2018). The main reason creation of
housing bubble was considered as providing housing loan at lower interest rates. Every person
was getting loan and buying property this created a situation that prices of property rose to sky
high with a high demand and low supply but with time the liquidity in banks stated to reduce and
people were unable to pay their loans back. Again situation came where the demand gets to nil
with prices falling down to there lowest. This is termed as burst of the housing bubble.
In an article by Federal reserve bank it was stated about housing bubble and monetary
policy that it is hard to spot and bubble before it burst and the Fed had limited policy to stop the
growing bubble in case it was spotted, the cost of making policy mistakes were very high,
monetary policy must be used to ensure that financial system is strong enough to withstand
when the bubble burst (Moroni, 2016). The crisis was determined by the Treasury secretory of
Fed Reserve back in 2006 as the US economy is due for some crisis. It was detected that US
wad up for some financial crisis but its actual origin was not found and the reason for this
recognition was that market was stable for sometime. Back I 2006 the staff of Fed reserve and
Security and exchange commission started to find out the reason for such trouble. All factors
were undertaken but the nationwide housing downturn was not taken into account, hence it was
not determined before the bubble burst.
Different view points and their evaluation:
Monetary policy should respond to asset prices if two conditions are met:
1. Equilibrium asset prices due to Market imperfections should deviate from their
fundamental value.
2. Deviations of asset prices from their fundamental price shall effect due to financial
friction.
It was argued that when these two conditions are met, the effect of asset prices on
economic activity is evident itself on variables such as GDP or inflation and so the monetary
authority should react to those variables directly and not to asset prices actually.
With a hit of housing bubble in the US global economy was hit hard and a major
recession was faces by the world. In this empirical evidence was given in the form of a policy
maker must consider the asset price before making any monetary policy. The composition for
this was given as the monetary policy can actually increase the price of the asset and the
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economy can enter in to housing price bubble. This was laid down as third condition for
responding to the asset price.
With this a fundamental question over monetary policy was addressed as the role played
by it in housing bubble crises. With liberal monetary policy the Federal reserves faces a major
fund crises after burst of housing bubble. It was suggested that policy maker should consider all
the tools and techniques that allows them to evaluated the serious after comes of the housing
bubble crises.
During the time of creation of housing bubble it was stated that it is the time of housing
boom and it was believed that risk of borrowing and lending can lead housing prices in one
direction only that is upward. If this was the case the risk related with lending and borrowing
against housing were negligible. People who purchased house could have enjoyed there new
property with growth in their income. The lenders were duly protected and the borrowers who
were not able to pay the loans could have refinanced or sold their houses (Summers, 2014). This
mind set was a huge turn on for people to purchase even bigger housed with larger mortgages.
This created a permissive mortgagee market and some crossed the line and indulged into
unethical and illegal acclivities this can be explained with an example people who belonged to
upper middle class category took hung loans sometimes amounting to $1 million and purchased
property which it a present times is worth of lesser value. This was a misfortune suffered by
innocents on greed and dishonesty of someone else.
With liberal monetary policies in the US made the federal Reserve to take undue
advantage and in turn become insolvent with no liquidity ans left the housing market to hit rock
bottom along with US and World economy shaken. With this many banks become insolvent with
no liquidity left and as result they were closed down.
The prices of real stated was stable in the US since mid nineteenth century. The prices
rise was seen form year 2006 and from Jan 2006 the prices reached to its peak. The rate of
housing property escalated by 18% (The U.S. Housing Bubble: Did The Fed Play A Role,
2018). It took a time frame of 10 years for housing bubble to burst. The reason behind this was
considered as excessive rise in the prices of housing property and looses monetary policies,
increment in foreign investors capital inflow, aim of fiscal polices at increasing home ownership,
purchase at large scale and securitizations of mortgages from government, low interest rate in
mortgages and acceptance of high mortgages. The Fed reserve were criticized for using such low
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interest rate mortgages and did not consider the credibility of mortgage taker with respect to their
ability to repay the loan amount in time. It was agreed upon that from 2001-2004, the federal
funds rate was well below from what they been predicted to. VAR methodology was considered
to determine the consistency in monetary policies and to determine relation between house prices
and federal fund rate.
With this an empirical and evident discussion it is determined that there is a grate link
between monetary policy of a nation and housing bubble as the main aim of theses policies is to
crest inflation and reduce unemployment hey must be precise with no loop holes and loose ends.
This can lead to housing bubble creation and with a brush bring a grate recession too.
Literature review:
The main argument for the creation of housing bubble in the US was considered as lower
rate housing interest given by Federal reserve. The monetary policies of Fed were too loose and
relative to Tyler rule. Tyler rule can be defined as the nominal interest rate that should response
to deviation of actual inflation rates from target interest rates.
With facing this crisis many paper, article and journals were published by various
professional and institution on determine the causes and effects of this crisis.
As per the research paper Monetary Policy and the Global Housing Bubble (Comment
on: “Monetary Policy and the Global Housing Bubble”, 2018) the Tyler rule created an effect of
deviation of house prices from their fundamental values. In this paper it was stated that there is a
direct statistical relationship between deviation of short term interest rates and from rates
prescribed by Tyler rule on the devastation of house prices from their fundamental value.
On the other hand article Housing Bubbles and Low Interest Rates (Housing Bubbles and
Low Interest Rates, 2018.) stated that housing prices have a fundamental or equilibrium value.
He considered two equation models from demand and supply side that drives in housing market.
In this it was observed that be foe 2002 the price fluctuation was minimal and but with decrease
in interest rated n housing loans the prices slowly started to rise and at s time reached to a level
that the prices can not be justified with their there fundamental prices.
According to article Monetary Policy and Housing Bubbles (Monetary Policy and
Housing Bubbles, 2018) this can be stated that the main reason for creation of housing bubble the
greed and dishonesty of mortgage brokers and securitization institution. As they channeled too
much money in the house, building buying. The monetary and credit standards failed in this
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process. Main factors of securing loan against valuable were ignored and generally at times
income lacked proper documentation of creditworthiness. In this the main victim were poor
people and this fact was determined with geographical study of mortgage lending. The subprime
borrower plied too much debt.
As per the study conducted by economists Manuel Adelino of Duke University (What
Caused the Housing Bubble, 2018). A conclusion was drawn as the mortgage endings were not
stargazed mainly at poor. In the earlier studies it was found out that the at research was done
while taking into consideration Zip codes and that found a sharp growth in poor neighborhoods.
The borrowers were assumed to reflect the average characteristics of residents but for actual
borrowers and found this wasn't true. They were found to more rich than actually showed in
studies.
CONCLUSION
For the above report it can be concluded that with experiencing the housing bubble crisis
many authors, analyst and professional came forward with different approaches regarding the
caused that caused housing bubble. From overall discussion from articles and journals it can be
said that the main reason of creation of housing bubble in the US was low interest rate mortgages
provided by Federals reserves. Some author did not connect with this point and stated that
mortgages was not targeted to poor class of peoples so it can be said that with burst in the
housing bubble they were the only who adversely effect. With this it can be interpreted that
monetarily policy of the nation have a direct effect on the creation of housing bubble as a slight
changes in the policies can effect the national as well global economy.
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REFERENCES
Books and Journals
Cheng, I. H., Raina, S. and Xiong, W., 2014. Wall Street and the housing bubble. American
Economic Review. 104(9). pp.2797-2829.
Moroni, S., 2016. Interventionist responsibilities for the emergence of the US housing bubble
and the economic crisis:‘neoliberal deregulation’is not the issue. European Planning
Studie., 24(7). pp.1295-1312.
Summers, L. H., 2014. US economic prospects: Secular stagnation, hysteresis, and the zero
lower bound. Business Economic. 49(2). pp.65-73.
Online
Comment on: “Monetary Policy and the Global Housing Bubble” . 2018. [Pdf]. Available
through :<http://www.fperri.net/papers/houseprices_comments.pdf>.
What Is a Housing Bubble?. 2018. [Online]. Available through
:<https://smartasset.com/mortgage/what-is-a-housing-bubble>.
Monetary Policy and Housing Bubbles. 2018. [Pdf]. Available through
:<https://cepr.org/sites/default/files/40006_LIMJAROENRAT%20-%20Monetary
%20Policy%20and%20Housing%20Bubbles.pdf>.
What Caused the Housing Bubble. 2018. [Online]. Available through
:<https://www.realclearpolitics.com/articles/2015/02/02/what_caused_the_housing_bubble
_125463.html>.
The Fed and the Crisis. 2018. [Online]. Available through
:<https://www.wsj.com/articles/SB10001424052748703481004574646100272016422>.
Housing Bubbles and Low Interest Rates. 2018. [Online]. Available through
:<http://archive.economonitor.com/blog/2016/03/housing-bubbles-and-low-interest-rates-
deja-vu-all-over-again/>
The U.S. Housing Bubble: Did The Fed Play A Role? 2018. [Online]. Available
through :<https://cpb-us-w2.wpmucdn.com/sites.udel.edu/dist/b/3646/files/2015/12/THE-
US-Housing-Bubble-Did-the-Fed-Play-a-Role-1lsk4li.pdf>.
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