By
Chris Buchheit on March 1, 2010
Remember the so-called “housing bubble” back in 2007? Economists were predicting its implosion for a long time, but many did not predict the fall of the financial industry.
The housing bubble was one of the chief causes of the financial meltdown. Some economists say that a lack of government regulation on the financial sector caused several banks to give mortgages to people who could not pay them back. These kinds of mortgages are known as “
subprime mortgages”, and they were a large part of the housing bubble. Banks gave cheap loans to people to buy houses they normally would not be able to afford, and ultimately those people did not have the money the pay back the loans. As a result, many of those people had to foreclose on their houses and banks had invested in loans that could not be repaid. The housing market suddenly tanked and banks had lost too much money on bad assets. If the banks had been more tightly regulated, these economists say, they would not have been allowed to give out the bad loans.
It was the government, according to Jeffrey Miron, a professor of economics at Harvard, that perpetuated the banks’ faulty business practices. He says that it was over-regulation that caused the recession, not a lack of it. The Fannie Mae and Freddie Mac mortgage lending institutions were chartered by the US government in 1938 and 1970 respectively. The federal government promised the two lenders that it would pay back the companies’ debt incurred by more subprime mortgage lending. In 1977, the government pressured the two companies to increase the lending of these kinds of loans until in 2007, economists realized that the housing market was doing artificially well. Once the bad assets outnumbered the good loans in the banks, the housing market fell.
In a nutshell, the housing bubble was caused by banks’ faulty mortgage lending practices. Whether you subscribe to one economic theory over the other, it cannot be denied that banks deliberately lending mortgages to people who cannot afford them is a bad business practice.