Housing Market Bubble Analysis
Monetary Policy and the U.S. Housing Market Bubble During the early 2000s, the United States entered a period of economic madness including the economic housing bubble. At the same time, the Federal Reserve had executed expansionary monetary policy by lowering interest rates in response to the recessionary period. But, what role, if any, did the setting of monetary policy play in the ensuing housing market developments? This report will analyze Dokko et al.’s (2009) report “Monetary Policy and the Housing Bubble” and attempt to answer this question. Dokko et al. (2009) used two models to analyze if monetary policy played any role in the housing market developments called the FRB/US and reduced-form vector-autoregressive models. The FRB/US
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Holt (2009) summarizes four primary causes to the housing market bubble and its collapse including: low mortgage interest rates, low short-term interest rates, relaxed standards for mortgages, and irrational exuberance. Mortgage interest rates were kept relatively low by the influx of foreign investments seeking low risk investments coupled with good returns. These investors eventually became emboldened by investing in riskier mortgage-backed securities. This kept the mortgage rates low allowing more home buyers to qualify for mortgages with low payments, including subprime mortgages, while home prices steadily increased. (Holt, …show more content…
Adjustable rate mortgages, or ARMs, are mortgages that lenders periodically adjust interest rates on based on an index and payments are adjusted accordingly (Federal Reserve Board, n.d., 4). With a steady increase in home prices, people were unable to avail for fixed-term mortgages so they flocked to the lower payments of ARMs. But as interest rates began to increase in 2004, so did the ARMs. Leveraging is the borrowing of money for investment. So, investors were taking out loans due to the low short-term interest rates and investing in risky, high return mortgage-backed securities, which contributed to increasing home prices. (Holt,
Holt (2009) summarizes four primary causes to the housing market bubble and its collapse including: low mortgage interest rates, low short-term interest rates, relaxed standards for mortgages, and irrational exuberance. Mortgage interest rates were kept relatively low by the influx of foreign investments seeking low risk investments coupled with good returns. These investors eventually became emboldened by investing in riskier mortgage-backed securities. This kept the mortgage rates low allowing more home buyers to qualify for mortgages with low payments, including subprime mortgages, while home prices steadily increased. (Holt, …show more content…
Adjustable rate mortgages, or ARMs, are mortgages that lenders periodically adjust interest rates on based on an index and payments are adjusted accordingly (Federal Reserve Board, n.d., 4). With a steady increase in home prices, people were unable to avail for fixed-term mortgages so they flocked to the lower payments of ARMs. But as interest rates began to increase in 2004, so did the ARMs. Leveraging is the borrowing of money for investment. So, investors were taking out loans due to the low short-term interest rates and investing in risky, high return mortgage-backed securities, which contributed to increasing home prices. (Holt,