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To begin with, the housing
bubble is considered as a core problem which contributed to the global
financial crisis of 2008. This financial crisis has its roots in the previous
century and, in particular, in the United States, when home prices began to
rise as a result of the increase in household income (beginning in 1992),
combined with a bipartisan political decision taken in 1997 about the
elimination of taxes on capital gains of up to a half million dollars for
residences1. 

First of all, the increase
in household income stemmed from the rise in stock prices. It is important to
mention that the housing bubble developed during the same time period as stock
bubble in the mid-90s. Consequently, the run – up of stock prices led to the
increase of people’s wealth and so they were willing to spend larger amounts of
money in order to invest their new stock wealth in the purchase of a new home.

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The housing market was on
the rise, which means that most of the investors wanted to invest their money
in housing. This continued growth in demand fuelled the creation of a housing
bubble because in the short – run the supply of housing is almost stable.
Subsequently, the rise of demand was followed by an increase in prices and the
expectations for a further rise led homebuyers to pay much more money for
buying a house than its real value was. Moreover, this consumption boom also
influenced the savings rate which reduced significantly from almost 5% in the
middle of the decade to just over 2% by 2,0002. The
immediate consequence of this phenomenon was the enormous increase in house
prices which had been relatively stable for almost half a century (from 1953 to
1995).

Another key cause of this
housing bubble is certainly the low mortgage interest rates. Although the U.S.
savings rate was extremely low, as mentioned above, the mortgage interest rates
kept declining because of an influx of savings from other countries such as the
United Kingdom and Japan and from countries with a developing economy such as
China, Brazil and others with huge oil exports. Investors in these countries
are targeting low risk and good return investments3. As
a result, they targeted U.S. government securities which are considered to be
risk – free, as well as mortgage – backed securities issued by Fannie Mae and
Freddie Mac, two of the biggest government – sponsored enterprises (GSEs). So
the investors supposed that in case something went wrong, the government would
have rescued Fannie and Freddie.

1 Steven Gjerstad and Vernon
L. Smith (2011, p. 109)

 

2 Dean
Baker (2008)

 

3 Jeff
Holt (2009)

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