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American Real Estate Bubble and Its Causes Essay


Factors that Caused the Real Estate Bubble

To understand the reason behind the real estate bubble and its subsequent impact on the 2008 financial crisis, it is necessary first to delve into the process of homeownership in the U.S. If an average person wants to purchase a home; they would usually need to pay hundreds of thousands of dollars. The only way they can get this amount is if they take out a home loan from a bank in the form of a mortgage. Every month, the homeowner that took out the loan from the bank needs to pay back a portion of the interest on the loan as well as the added interest. The process seems innocuous enough and, on the surface, does not appear to contribute to the real estate bubble.

However, when combined with speculation on loan interest rates and looser bank lending policies, that is when the problems start to arise (Claessens and Kose 240). The start of the real estate bubble can be traced to the early 2000s when local and foreign investors, looking for little risk yet high return investments, viewed the U.S. housing market as a prime investment location. Instead of investing in actual plots of land or real estate development projects, the investors focused on the interest rates that can be accrued from the mortgages people took out on home loans (Adebambo, Brockman, and Yan 655).

The result was various financial institutions buying thousands of real estate mortgages, bundling them up into mortgage-backed securities and selling them to investors (Brummer 437). Initially, this did create a viable financial asset since, at the time, banks only gave loans to people that they had properly vetted, had good credit and could pay the bank back over time for the loan. At the time, mortgage-backed securities were a good investment; however, since the demand for these types of securities was at an all-time high, various lenders attempted to create more of them through questionable practices.

The most prevalent of these practices was the creation of subprime mortgages which is a loan to a person that has a poor credit history. In fact, in some cases, some banks did not even check the credit history of a person and even utilized predatory lending practices just to get people to take out loans. The combination of looser lending policies and lower home loan interest rates during the early to mid-2000s resulted in a rise in demand for real estate in the U.S. Speculation on home prices became rampant with the assumption that they would continue to increase which made the average citizen believe that purchasing a home at this time was an excellent investment opportunity since they could cash in on the higher value of their home later on (Carvalho, Ferreira and Matos 1170).

Unfortunately, the combination of speculative home pricing, issuing risky loans and predatory mortgage practices resulted in some borrowers being unable to pay for the expensive homes they purchased. As a result, numerous borrowers defaulted on the loans they took out which put a lot of homes back into the market. At this point, there were relatively few buyers resulting in an excess in supply and weak demand (Christoffel and Kuester 867). This created a shift in the real estate market which led to a dive in the price of housing. Many homeowners suddenly found themselves paying for mortgages for homes with a significantly reduced value which caused them to stop paying for them. It is the combination of the aforementioned events that led to the “popping” of the U.S. real estate market.

Critical Steps to Address the Economic Problems

A lot of people state that the problem with the present-day economy can be traced to the rampant inequality that is present. However, when you look at how our society operates, inequality is necessary since it does not make sense to pay someone the same rate for a mundane job as compared to an individual that spent nearly a decade in school learning their craft (ex: salaries for janitors versus salaries for doctors).

This does not mean though that people should accept lower salaries simply because they have menial jobs. Christoffel and Kuester pointed out that all individuals have the right to a decent standard of living based on the pay rate that keeps up with the current rate of inflation (Christoffel and Kuester 865). Unfortunately, studies such as those by Mani indicated that base pay rates have stopped keeping up with inflation since the 1950s with the average American citizen receiving substantially less pay as compared to their counterparts during the mid-1950s (Mani 15). Katz explained that this is in part due to a lack of sufficient regulation regarding minimum wage rates to keep up with inflation. While this may not seem like an economic problem, you need to understand that consumer spending is at the heart of all business activity (Katz 1).

The higher the rate of consumer spending, the healthier the economy is. However, the opposite is also true, and this is where the current problems in our economy can be traced. If the income of ordinary consumers does not keep up with the rate of inflation, this means that over time people are going to be able to buy less and less with the amount of money they have. Over time, this leads to people questioning the effectiveness of the current economy since they will notice that they no longer have the same spending power that they used to have. While the obvious solution is to raise current minimum wage rates so that they match the rate of inflation, this plan is opposed by numerous parties who state that increased minimum wage could hurt the economy rather than help it. This is supposedly due to the external competitive forces from manufacturing giants like China where labor is much cheaper.

As such, the U.S. economy finds itself in a conundrum where to solve its current issues it would need to raise its minimum wage to match the rate of inflation but it cannot do so since this would make less competitive which would cause its economy to get worse resulting in a lot of people losing their jobs. The only feasible way that such a problem could be resolved is if the country can increase its competitiveness in such a way that raising its minimum wage to match the current rate of inflation would not leave it vulnerable to external markets. This would mean that its manufacturing industry would need to shift from developing cheap goods that can be produced easily elsewhere to creating merchandise that can only be created within the U.S. based on local standards of production.

To pull this off, the government would need to create more subsidies for up-and-coming companies that have the potential to be game-changers to how people approach particular products. For example, the current subsidies that the U.S. gives to electric car owners have helped to popularize Tesla Motors and helped it to rival many local and foreign car companies. With its facilities located in the U.S., the company has contributed to creating more jobs in the local economy and pays more than the going rate for minimum wage. Examples like this show that the problems in the country’s economy can be overcome if proper investments and incentives are implemented by the government to encourage the success of such companies.

Economic Problems and the Financial Industry

To understand the true scope of the challenges facing the U.S. economy, it is first important to understand its rise into becoming an economic juggernaut. After World War 2, the U.S. initiated the Marshall Plan, which focused on providing aid to countries devastated by the effects of the war. What is interesting to note though is that during this period many European and Asian countries were introduced to U.S. foreign goods and many contracts for infrastructure development and shipping went through U.S. companies.

Since America could now shift its massive war factories into the production of common goods, this resulted in the U.S. becoming one of the primary sources of industrialized products in the world. This trend continued well into the 1960s and 70s as American goods and expertise continued to dominate the global market. As the world became more interconnected through globalization, various American based companies noted the potential of having factories in other countries to lessen the cost of labor due to differences in minimum wage costs. Initially, it was seen as an effective method of cost-cutting; however, what was not anticipated by these companies was that their methods and technologies were copied and utilized by local businesses in the places that they originally outsourced to.

The result was that prowess and technologies of various American companies are now in the hands of other foreign companies resulting in the present-day situation where goods made in India and China are cheaper and, therefore, more in demand compared to their American counterparts. Various American based manufacturing companies at times have no choice by export their methods of production and run the risk of losing intellectual property and hard-earned technological prowess.

Companies need to outsource to survive, and this has created additional economic problems for the U.S. since its manufacturing industry has been severely hit by cheaper outsourced labor. While there have been attempts at rectifying this through the use of subsidies and tax exemptions, the practice continues to this day, and this has severely hampered America’s industrial might.

Pursuing Major Players and Firms on Wall Street

The problem with seeking major players and firms on Wall Street is that these individuals and businesses are usually so interconnected into the present-day economy that prosecuting them or attempting to penalize them in various ways can cause more economic harm than good. While the numbers on the various stocks, bonds, and derivatives on Wall Street may seem confusing, they can all be boiled down to a single concept: the belief in the value of a product.

The product, in this case, can come in the many shapes and sizes such as the company value or the potential impact of outside forces on brand popularity. Actively going after different firms and people responsible for the financial could send a cascading level of doubt on the continued viability of the U.S. financial system which could cause significant capital flight. As such, it is recommended that the government put into place laws and regulations to prevent the 2008 financial crisis from happening again rather than trigger a new crisis by arresting and prosecuting various financial firms.

Works Cited

Adebambo, Biljana, Paul Brockman, and Xuemin (Sterling) Yan. “Anticipating The 2007–2008 Financial Crisis: Who Knew What And When Did They Know It?.” Journal Of Financial & Quantitative Analysis 50.4 (2015): 647-669. Print.

Brummer, Chris. “Origins Of The Financial Crisis And International/National Responses: An Overview.” American Society Of International Law: Proceedings Of The Annual Meeting (2010): 435-438. Print.

Christoffel, Kai, and Keith Kuester. “Resuscitating The Wage Channel In Models With Unemployment Fluctuations.” Journal Of Monetary Economics 55.5 (2008): 865- 887. Print.

Claessens, Stijn, and M. Ayhan Kose. “The Financial Crisis Of 2008–2009: Origins, Issues, And Prospects.” Journal Of Asian Economics 21.3 (2010): 239-241. Print.

Katz, Eric. “Hourly Federal Employees Will Receive A Pay Raise Too.” Government Executive (2015): 1. Print.

Mani, Bonnie G. “The Human Capital Model And Federal Employees’ Pay: Gender, Veteran Status, And Occupation.” Gender Issues 30.1-4 (2013): 15. Print.

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IvyPanda. 2020. "American Real Estate Bubble and Its Causes." July 19, 2020. https://ivypanda.com/essays/american-real-estate-bubble-and-its-causes/.

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