The last few years have been economically challenging, to say the least, and in the mires of our jobless “recovery,” sometimes it is hard to remember how we got here in the first place. The US housing crisis was indeed the notorious precursor to the devastating global recession of the past few years. A very brief timeline for how the housing bubble burst is as follows.
In the years leading up to the crisis, foreign money was flowing heavily into the US. This, combined with really low interest rates in the early part of the decade made it very easy to obtain a mortgage, which initiated the steep rise in housing prices. Then, investment banks and hedge funds got in on the action, but they aren’t regulated like regular banks (due to the repeal of the Glass-Steagal Act in 1999). Mortgage-backed securities, which are financial instruments that derive their value from housing prices and mortgage payments, became the hottest gadget on Wall Street and prompted a lot of predatory mortgage lending and outright fraud.
Prices rose steeply (see chart above) until around 2005-2006, when interest rates rose and housing prices began to moderately decline. The fragile system on which the mortgage bubble grew began to crumble. Refinancing mortgages that borrowers had taken on, believing housing prices would keep rising, became more difficult and the rate of foreclosures began to increase. The investment banks and hedge funds lost huge amounts when mortgage backed securities rapidly declined in value.
The damage of the housing bubble bursting was massive. Americans lost a lot of their net worth, especially retirement savings. Of course, many people lost their homes. Lehman Brothers and other major financial institutes failed. The auto industry was devastated. And the global economy was brought to its knees.
The housing crisis and its global aftermath was avoidable had the financial system been properly regulated. It remains to be seen whether the too broadly defined Dodd-Frank Wall Street Reform and Consumer Protection Act, signed in July 2010, will have a positive impact. According to member economist Robert Pollin, it includes a lot of holes, but those holes can and will be filled. Perhaps the incredible momentum generated by the Occupy Wall Street movement will provide the political will to do just that.
Created by CPE Member Economist Zhongjin Li and Sue Holmberg
October 2011
Data Source: http://www.caseshiller.fiserv.com/fiserv-case-shiller-home-price-index-changes.aspx
Sources:
“The Giant Pool of Money.” This American Life. http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-pool-of-money
Pollin, Robert. “Field Notes on Wall Street Reform: The Battle Continues.” Economic Prospects. The Labor Forum.
