Who is To Blame for the Housing Boom and Bust?

With house prices falling in the US and now UK, it is worth asking - who if anyone is to blame for the boom and bust in the Housing Market? This might help avoid a future boom and bust in the future.

1. Monetary Authorities.

In the US, we can point to how low interest rates were in the period 2002-2003. With interest rates less than 2%, mortgages became affordable to an increased number of income groups. The Fed appeared unconcerned about the housing boom and did nothing to prevent house prices rising rapidly. The same occured in the UK, the MPC only targetted CPI inflation. By stating there was nothing to worry about, the monetary authorities encouraged over confidence in the housing market and led to rising prices. If the Fed or MPC had taken action to take the steam out of the housing bubble, they would have avoided much of the boom and bust.

The Monetary authorities will defend themselves by arguing that the housing market doesn’t fall into their remit. ALan Greenspan claims there was nothing he could do to influence asset prices. [link] Their target is primarily low inflation and maintaining economic growth - not house prices. The Fed argued that in 2002, the US faced a real prospect of an economic downturn and they kept rates low to avoid this.

• However, the weakness of this argument is that the housing market has a very powerful influence on the economy. Because housing accounts for so much wealth in the economy, falling house prices are sufficient to tip the economy into recession. Therefore, Monetary authorities need to consider stability in the housing market as necessary precursor to a stable economy.

The Government

The government will say that they are not responsible for house prices; they are determined by supply and demand in the market. However, one area where the government could have done more is in the regulation of financial markets. Particularly in America, the mortgage sector behaved in a short sighted and irresponsible way, lending to people who couldn’t afford payments. In this particular area, the government made  a mistake in assuming the financial system could regulate itself. Better regulation of the financial sector could have placed greater restrictions on lending to new mortgage holders. If people needed to demonstate a better ability to repay, many of the subprime defaults could have been avoided. In the US and UK, there is a strong belief in the efficiency of markets and somehow government regulation represents a failure. But, the subprime crisis illustrates how unrestrained free markets can create serious problems for the whole economy.

In the UK, the government could have done more to increase supply, especially in areas of high demand. Increasing supply would have helped deal with the shortage of housing that was a major factor in rising prices.

Speculators.

It is argued this housing boom saw a rise in the number of housing speculators, such as buy to let investors. This new speculative element pushed up prices; but now they are falling, they will leave the market and cause prices to fall by a bigger amount. However, most buy to let investors say they are investing for the long term not the short term. Nevertheless any increase in the number of speculators  - people looking for capital gains as opposed to buying a house to  live in it, will make the housing market more volatile.
Estate Agents

Estate agents could be blamed for ‘talking up the market’.  - nncouraging higher prices by mentioning the strength of the housing market and how unlikely it is that house prices will fall. However, I find this argument rather tenuous. Estate agents may talk up the strengths of the housing market, but this is insufficient to increase prices unless there are real reasons behind them. At the end of the day, prices are determined by what people are willing to pay, not what estate agents want them to go for.

Just Market Forces.

The other argument is that the boom in house prices merely represents the working of market forces. With a shortage of supply in the UK, and rising demand, people were willing to pay higher house price / income ratios causing prices to rise sharply. This same factor explains why prices in the US are falling.

Greed

I put this down because I see it mentioned so often in newspaper comments. I think it is a poor argument and reflects what could be termed ‘taxi driver economics’. Buying a house, even at the height of the boom, was not necessarily a reflection of greed; but, simply a reflection that buying a house offered various advantages to homeowners as opposed to renting.. It wasn’t greed that caused people to sell house prices at a high price, it was a reflection of the market forces currently in operation.

• However, one area where the ‘greed argument’ is relevant is in the selling of subprime mortgages to people who had poor affordability. Mortgage companies were mainly interested in selling mortgages and not whether they provided a realistic loan to vulnerable people. It was this misselling of mortgage loans which caused so many problems in the credit markets.

See also:

Overvalued housing markets at economics help

Boom and Bust In US housing Market 

Are central banks really to blame for housing bubble MSN news