What We Can Learn From the 2008 Housing Market Crash

People who were caught in the 2008 crash may be spooked that the pandemic will lead to another crash. But the 2008 crash was caused by forces that are no longer present. 

First, insurance companies created credit default swaps that protected investors from losses in derivatives such as mortgage-backed securities.

To meet this demand for mortgages, banks and mortgage brokers offered home loans to just about anyone. They didn’t care about the credit-worthiness of subprime mortgage borrowers. Banks simply resold the mortgages on the secondary market. This created greater risk in the financial markets.

The entrance of so many unqualified buyers into the market sent prices soaring. Many people bought homes only as investments. They exhibited irrational exuberance, a hallmark of any asset bubble.

In 2005, homebuilders finally caught up with demand.18 When supply outpaced demand, housing prices started to fall. New home prices fell 22% from their peak of $262,600 in March 2007 to $204,200 in October 2010. That burst the bubble. 

But the Fed ignored these warnings. The Financial Crisis Inquiry Commission found that the Fed should have set prudent mortgage-lending standards. Instead, it only lowered interest rates. That generally gives the economy enough liquidity to fuel growth.

The Fed underestimated the size and impact of the subprime mortgage crisis in 2006. Many of the subprime purchasers were individual investors, pension funds, and retirement funds. They invested more heavily in hedge funds, spreading the risk throughout the economy.

Leave a Reply