The economics of Housing Bubbles in American’ Housing Crisis
A case of Government failure
What is housing bubble?
Chardes Kindleberger (1987) define a bubble this way: a sharp rise of price of an asset or a range of assets in a continuous process with the initial rise generating expectations, of further rise and attracting new buyer. Generally speculators are interested in profit from trading rather than in use or earning capacity. The rise is then followed by a severe of financial crisis – in short bubble burst.
There are many researchers who often focus on specific aspects of this general concept such as rapidly rising prices (Baker 2002), unrealistic expectations of future price increases (Case and Shiller 2003); the departure of prices from fundamental value (Garber 2000), or a large drop in prices after the bubble pops
In American, as main other economist, Herring and Wachter (2003) who show that many financial crises are the result of bubbles in real estate markets. It is similar with the financial crisis in American because the real estate bubble affect both financial system and the real economy. According to Franklin Allen (2009) Who is an economy specialist in University of Pennsylvania, he stated that everything became uncertain what things were worth, for example of increasing and dropping significant of stocks, or commodities as well. Around this issues, many studies has been carried out to find out many aspects of real estate bubble, especially is the causes of occurring housing bubble. Here, Mark Thornton stresses ideas about the government’s responsibility with housing bubble in American. In the research of Mark Thornton, he states that there are three reasons of housing bubble such as reals factors, psychological causes and the final one is changes in both real factors and market psychology, this idea is based on the Austrian business cycle theory. His three ideas is also mentioned by Chicago school and proponents of Supply-Side economics, Keynesians and Austrian school for each point of view correspondingly. The first idea
The purpose of literature
The purpose of this chapter is to show how the “system” works, why it generates bubbles, why they eventually burst, and the macroeconomic effects of bubbles. Here we apply the economic understanding of bubbles derived from the Austrian business cycle theory (ABC theory)6 to the current case of the housing bubble and show that this aspect of the housing crisis is the result of government failure—the inevitable failure of a government bureaucracy (i.e. the Fed) to manage the money supply and interest rates in an economically rational manner.7 However, the same reasoning can be applied to historical bubbles, from the Tulip mania in 17th century Holland (see French 2006) to the dot.com tech bubble of the late 1990s (see Callahan and Garrison 2003), and to future bubbles. The causes of bubble
There are three basic views of bubbles that are held by economists and the general public. The dominant view among the general public and modern mainstream economists, including the Chicago school and proponents of Supply-Side economics, is to deny the existence of bubbles and to declare that what is thought to be “bubbles” is really the result of “real” factors. The second view, which is espoused by Keynesians and by proponents of Behavioral Finance, is that bubbles exist because of psychological factorssuch as those captured by the phrase “irrational exuberance.” The third view is that of the Austrian school, which sees bubbles as consisting of real and psychological changes caused by manipulations of monetary policy. This view has the advantages of being forward looking and identifying an economic cause of bubbles. By identifying an economic cause it also directs us to policy choices that would prevent future bubbles.
As you can see, the first view wishes to dismiss psychological…