The 2008 Housing Crisis: Causes, Effects, and Lessons Learned

Introduction 

The 2008 financial crisis affected different sectors of the economy. According to the National Bureau of Economic Research announced that the economy entered a recession in December 2007, and by December 2008, the economy had experienced a growth of only 0.4 percent (Holt, 2009). Unemployment rates rose from 5.4 percent in 2007 to 9.5 percent in 2009, and the Dow Jones Industrial Average (DJIA) fell by approximately 55 percent from 2007 to 2009. The consensus is that the primary cause of the 2008 financial crisis was the housing bubble (crisis) that caused the credit crisis. Thus, the purpose of this research paper is to explore the causes and the effects of the 2008 housing crisis and its role in the financial crisis. 

Causes of the Housing Crisis 

The 2008 housing crisis played a crucial role in the financial crisis such that the history of the two events are intertwined. According to Pajarskas &Jociene (2014), the economy was experiencing slow growth at the beginning of the 21st century due to shift in investment. The tech bubble in the 1990s has adversely affected the market, and the 2001 terrorist attack only made the situation worse. The 2000 era saw a drastic decline in stock market investment, and the Federal Bank reduced the interest rate. The lower interest rates made mortgage investments cheaper, and many people began investing in the housing market. The housing market was seen as an alternative high-risk investment to the stock market that would bring in good money. The house prices began rising as early as 2004, hence the beginning of the housing bubble. The house prices kept rising due to real estate speculation, and investors and consumers began to see homeownership as the best form of investment. 

The US financial institutions adopted irresponsible mortgage lending whereby loans were given to “subprime” borrowers even those with poor credit histories (Chari et al., 2008). Lending institutions believed that housing prices would continue to go up; hence they discarded the lending standards and gave out mortgages to even individuals with poor credit history. Intermediaries also played a role as banks attempted to disperse the credit risk as subprime lending continued to grow. Investment banks, hedge funds, and structured investment vehicles also wanted a piece of the growing housing market. However, the housing bubble busted by the second quarter of 2006 leading to a decline in house prices. Banks had spent a lot of money on mortgage-backed securities, and yet real estate investors and individual homeowners could no longer afford to pay back the interest because the value of the homes had declined. Many mortgage borrowers had no choice but to default payment of their loans, thus the subprime mortgage crisis. 2008 witnessed a lot of foreclosures while the banks were left with illiquid mortgage-related securities which created big holes in the balance sheets of financial institutions spilling over to the entire economy and global economy, eventually causing the long and painful recession (Stone, 2009). 

The financial institutions do not take the entire blame as the government played a role. The government relaxed the mortgage lending standards such that the mortgage market was no longer regulated (Samuelson, 2015). The government encouraged financial institutions to give out mortgages, and it encouraged businesses and those who wanted to buy homes by reducing the interest rates. 

According to Holt (2009), low mortgage interest rates and relaxed standards were not the only factors to blame as irrational exuberance also played a role. The 2008 housing bubble progressed just like any other bubble in other sectors of the economy. Holt (2009, p. 125) defines irrational exuberance as “heightened state of speculative fervor.” All the stakeholders involved in the housing bubble including government regulators, investment bankers, credit rating institutions, foreign investors, insurance firms and homeowners acted on the assumption that home prices would continue to rise. Home prices had not fallen in a single year since the Great Depression, and everyone assumed that home prices would not fall. The universal assumption made the investors increase their housing investments, while the government, financial institutions, and regulatory bodies continued to discard the standards. A homeowner who sold a house in the first quarter of 2003 would have sold it for 28% less than the price by the second quarter of 2007. The increase in price only fueled the exuberance such that the investors and financial institutions did not pay any advice to the warnings of the impending housing crisis. 

How Many People Were Affected? 

In 2007, the American economy was in turmoil because of the housing crisis. Many investors and financial institutions were caught up in the housing bubble, and when the housing prices declined a chain of reaction took place. Financial institutions that had pooled their resources or insured mortgages were not spared given the degree of the financial damage caused by the housing crisis (Armstrong, 2011). 

It is hard to evaluate the specific number of individuals affected by the housing crisis or the financial crisis as small, medium and large-scale organizations were affected. When homeowners could no longer afford to pay back the bank loans and interests, foreclosure rates increased. According to Pajarskas & Jociene (2014), foreclosure rates increased by 55% between the second quarter of 2006 and the end of 2007 prime mortgage, and it increased by 80% for the subprime mortgage. Foreclosure rates for ARMs increased up to 400%. The foreclosure rates show that homeowners were affected the most. 

According to Holt (2009), the losses also spilled to the entire financial system with mortgage lenders, investment banks, foreign investors and insurance companies incurring massive losses. Mortgage lenders such as the Countrywide Financial and New Century Financial filed for bankruptcy while others were liquidated. Investment banks were also affected, with one of the largest investment banks in the US- Lehman Brothers filing for bankruptcy. Other investment banks that were on the verge of bankruptcy or collapse were acquired by others firms while others became commercial banks to avoid uncertainty and low regulation associated with investment banks. Foreign investors, particularly banks and governments, who had invested in the mortgage-backed securities were also affected, and this explains why the housing crisis had global effects. Lastly, insurance companies such as AIG who had sold credit default swaps to homeowners and investors made a lot of losses as the financial institutions went after them to recover the loans (Armstrong, 2011). 

As the housing crisis worsened in 2007, the financial market was still stable until September 2008 when the market fell by 20% in comparison to the October 2007 peak. The government took over the Federal National Mortgage Association as the subprime mortgage market was blamed for the economic crisis. On September 14, 2008, Lehman Brothers declared bankruptcy due to overexposure to the subprime mortgage market. The closure of Lehman Brothers became the largest bankruptcy filing in the US, and the next day, the market plummeted further, and Dow Jones went down by 499 points. The fall of Lehman Brothers led to panic in the money market, and investors made massive redemption requests. 

Pajarskas & Jociene (2014) state that the International Monetary Fund (IMF) expected the total loss of the housing crisis to reach $ 1 trillion, but in October 2008, the number was revised to $1.4 trillion. According to Melendez (2013), the paper wealth lost by the US homeowners was $9.1 billion, whereas financial institutions lost a significant amount. The $9.1 billion failed to take into consideration the economic losses associated with foreclosures and unemployment. On the other hand, the economic crisis of 2007-2009 took a toll on the economy by approximately $13 trillion (Melendez, 2013). 

How Long Did it take for the Market to Stabilize? Who Paid the Debts? 

The US housing market has come a long way since 2007. When the housing market was at its peak in 2007, the median sale price for a home was at $200,000, but it reduced by 29% to $140,000 after the housing bubble (Pajarskas & Jociene, 2014). As early as 2014, the housing market began stabilizing and experienced a stable annual growth. In 2017, the median sale price for a home is $199, 200 making it safe to assume that housing market has stabilized. The market has not only stabilized, but the prices have increased up to the 2007 prices. 

On the other hand, the US economy also took a number of years to recover after 2008 economic crisis. The government came up with the stimulus package known as American Recovery and Reinvestment Act with the aim of reinstating the American economy to its previous state in one year. The stimulus package stabilized the economy, but the recovery took longer. It has taken almost ten years for the American economy to reduce its unemployment rate to the way it was before the economic crisis. 

As the housing crisis continued, the government had no choice but to step in to save homeowners and the financial institutions affected. Pajarskas & Jociene (2014) discuss the creation of the Mortgage Forgiveness Debt Relief Act (MDRA) created in 2007 to help homeowners affected by the housing crisis. MDRA provided tax relief to homeowners after they were discharged from their mortgage obligation or when their houses were placed in foreclosure. MDRA worked like debt forgiveness, and it helped some homeowners to hold on to their homes. 

The government also stepped in to mitigate the effects of 2008 economic crisis. As of September 18, 2008, the government began the bailout process through the creation of the Troubled Asset Relief Program (TARP) which availed over $1 trillion to buy toxic debt from financial institutions to prevent a complete economic crisis. The Securities and Exchange Commission (SEC) got rid of short-selling stocks on financial companies to prevent investors from pulling out to stabilize the money market. As the government continued to intervene the money markets began experiencing an upward trend, and this assured the investors that the situation was under control (Chari et al., 2008). 

The government also set aside $700 billion to assist financial institutions. The US Treasury used the money to buy risky and nonperforming debt from lending institutions. The primary debt being mortgages, but auto loans, college loans, and ambiguous bad debt was also included. $250 billion was infused into the banking system to encourage bank-to-bank loans and other kinds of lending. The government’s aim was to enhance liquidity in the banking system as banks had reduced their operations to save money. The additional financing from the government was used to pay wages, provide critical services and reinstate backs to the pre-economic crisis state. 

How Many Companies Closed Down 

The 2008 subprime mortgage crisis and economic crisis led to the closure of many businesses. Biggest closures such as Lehman Brothers and AIG receive a lot of attention, yet a lot of small and medium scale businesses were also closed down. According to Kavoussi (2012), over 170,000 small businesses closed down between 2008 and 2010. The number of self-employed individuals fell by 4% from November 2007 to June 2009. Approximately 50 businesses were shutting down every day during the recession, particular businesses in the real estate and financial sector. 

Conclusion 

In conclusion, the subprime mortgage crisis has negative implications for the American and the global economy. The housing crisis was the primary cause of the 2008 financial crisis that did not spare even the largest financial institutions in the US. When Lehman Brothers filed for bankruptcy, the economy was thrown into disarray, and if the government had not intervened immediately, the market could have suffered beyond repair. The housing crisis is a source of valuable lessons on financial regulation. The government and financial regulatory bodies should operate by the standards to avoid falling victims to bubbles in future. 

References 

Armstrong, M. D. (2011). From the Great Depression to the Current Housing Crisis: What Code Section 108 Tell Us about Congress's Response to Economic Crisis.  Akron Tax J. ,  26 , 69. 

Chari, V. V., Christiano, L., & Kehoe, P. J. (2008). Facts and Myths about the Financial Crisis of 2008.  Federal Reserve Bank of Minneapolis Working Paper ,  666 . 

Holt, J. (2009). A summary of the primary causes of the housing bubble and the resulting credit crisis: A non-technical paper.  The Journal of Business Inquiry ,  8 (1), 120-129. 

Melendez, E.D. (2013). Financial Crisis Cost Tops $22 Trillion, GAO Says. HuffinPost. Retrieved from: 

https://www.huffingtonpost.com/2013/02/14/financial-crisis-cost-gao_n_2687553.html 

Pajarskas, V., & Jociene, A. (2014). Subprime mortgage crisis in the United States in 2007-2008: causes and consequences (Part I).  Ekonomika ,  93 (4), 85. 

Samuelson, R. (2015). What Caused the Housing Bubble? RealClear Holdings LLC. Retrieved from: 

https://www.realclearpolitics.com/articles/2015/02/02/what_caused_the_housing_bubble _125463.html 

Stone, M. E. (2009). Housing and the financial crisis: Causes, consequences, cures.  Housing Finance International ,  24 (1), 34.