ECO PAPER

Special Topic 5- The Crisis of 2008: Causes and Lessons for the Future

1.) Why did housing prices rise rapidly during 2001-2005 and then fall in the years immediately following? Did regulation and monetary policy play a role in this housing boom and bust cycle?
“During the years of 2001-2005 housing prices rose due to the fact that the mortgage default rate and the foreclosure rate was at an all time low” (pg.671). The government was making new standards for housing loans and mortgages, which made them more affordable and easier to get, even if you didn’t actually meet the old standards you could still be eligible for loans and mortgages. Immediately after this housing boom, a bust arisen in the housing prices. The bust was caused because many of the monthly mortgage payments stopped coming in. This was because mortgage loans were made to more people whose chances of repaying them were less than in the past. These mistakes can simply be blamed on misjudgments by the banks and other leaders. When millions of these payments stopped coming in, there was no amount of financial expertise on Wall Street or government help that could save the whole investment structure built on the foundation of those mortgage payments. Government regulation and monetary policy played a significant role in the housing boom and bust cycle because government regulations and interventions are precisely what pushed lending institutions to reduce the standards which they had traditionally required of prospective borrowers before making mortgage loans to them. This lowering of mortgage loan standards, and the riskier loans that resulted, were crucial to the bust and caused the American economy to collapse, which in turn was felt internationally.

2.) What caused the crisis of 2008? Was it mortgage lending standards and the broader issue of American public policy that encouraged home ownership? Was it the Federal Reserve policy that kept interest rates too low for too long? Was it the “greed” of Wall Street firms and other bankers? Was it also “greed” of individuals who purchased homes they could not afford? Discuss each of these causes and then identify the one that you consider to be the most important factor.
The cause of the crisis of 2008 can be summed up into one word and that word is greed. Mortgage lending standards at that time did in fact encourage home ownership. Mortgage lenders were happy to lend money to people who couldn’t afford their mortgages, because at the time there was nothing to lose. These lenders were able to charge higher interest rates and make more money on “sub-prime loans” (pg.674). If the borrowers default, they simply seized the house and put it back on the market. The keeping of the low interest rate for too long eventually led to tons of houses being sold, but then caused the payments not be made. This in turn forced lenders to sit on more and more foreclosures than they could sell. Mortgage-backed securities became more risky and worth less causing investment firms to suffer. Another big factor in the crisis was the overflowing greed that swept over Wall Street and bankers. Mortgage brokers, acting only as middle men, passed on the responsibility for loans on to others in the form of mortgage backed assets, which they took a fee out of for themselves. They would group these “bad” mortgages together and resell them, which they called “investments” and led to even more money for them. Eventually these “investments” could not be paid for and had to be foreclosed, thus costing the brokers to lose money and eventually led to a recession. Greed from the individuals that bought these homes they could not pay for also was a small part of the crisis of 2008. People wanted to own there own homes and some saw this as like a life goal and a trend, even if they knew they didn’t have the money to pay for it. Soon the problem of not being able to pay for the mortgage payments, began to set in and helped cause our economy to go into

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