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The Real Causes of the Housing Bubble and Credit Crisis.

The three main causes of the housing bubble were historically low interest rates, government policies that encouraged home ownership by as many people as possible, and rampant speculation. It was a "perfect storm" as all three factors converged at the same time to create an environment where common sense was replaced by greed, ignorance, and incompetence. The credit crisis was not directly caused by the "poor" although many at the lower end of the income spectrum were caught up in the consequences of the three converging storm fronts.

The initial trigger that began to inflate the bubble was the tragic events of September 11, 2001. A year earlier, the federal funds interest rate was 6.5%. The terrorist attacks prompted the Federal Reserve to start chopping interest rates dramatically as it feared that dire financial repercussions would quickly paralyze the economy. Hindsight clearly shows that they overreacted when forecasting the potential economic impact, but the effects of the continuing rate cuts were not obvious at the outset. With the exception of the travel industry, particularly the airlines, the economy remained relatively robust.

As the fed funds rate continued to drop to 1.0% over the next two years, this provided rocket fuel to homebuilders as they ramped up land purchases and massive housing developments. At this point, the housing bubble was fully underway. At the same time that interest rates were plumbing historic lows, certain members of congress were pressing Freddie Mac and Fannie Mae to expand their lending policies to be more inclusive of people who would not normally qualify for a home mortgage. This was accompanied and exacerbated by new and creative financing schemes that featured no principal payments for the first five years and teaser variable rates that were locked in for the same period of time.

All of this was a recipe for disaster and many of the "poor" ended up as its unsuspecting and unintended victims. Those mortgage rates would soon be adjusted upward as the Fed began to comprehend the error of its ways and started to methodically increase rates. The proverbial cat, however, was already out of the bag. The speculators, some of whom had been burned in the dot-com stock implosion just a few years earlier, had turned to real estate as the next get-rich-quick scheme. Greed quickly replaced reason as "flippers" bought up homes and condos at an alarming rate, with the intention of holding them for a matter of months and then reselling them at a big profit. In many cases these transactions were accomplished before construction on the properties was even completed.

This lethal combination of cheap money, easy credit, and gambling on future price inflation eventually undercut the housing market which was essentially a house of cards built on a foundation of quicksand. The effects of this were especially severe in those areas that were most overbuilt and where speculation reached extreme levels.
Parts of California, Florida, and Nevada experienced exponential price gains as people refinanced their existing homes to buy investment properties. This leveraging couldn't last forever and it didn't, as buyers walked away and sellers flooded the market. The resulting foreclosures across a wide price spectrum further compounded the problem, as prices cascaded downward in many hard-hit parts of the country.
Unfortunately, it's not over yet.

Learn more about this author, Michael Sanibel.
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