What caused the housing bubble in 2007

Financial markets

Stormy-Annika Mildner

Dr. Stormy-Annika Mildner is a member of the institute management of the Science and Politics Foundation (SWP) and has headed the Transatlantic Risk Management project funded by the BMWi since 2012.

The causes of the financial and economic crisis are manifold and it is not possible to simply assign blame. One thing is certain, however: the crisis was the result of both market and regulatory failure. The financial and economic crisis has now turned into a debt crisis. The way out remains long and rocky.

Dollar notes (& copy picture-alliance / AP)

Introduction: a chain of unfortunate coincidences?

"The financial crisis was avoidable" - this was the verdict of the ten-person Financial Crisis Inquiry Commission (FCIC) established by the US Congress in early 2011 in its report "Final Report of the National Commission on the Causes of the Financial and Economic Crisis" in the United States ". [1] The financial and economic crisis of 2007-2010 was not a "perfect storm" - a chain of unfortunate circumstances that no one could have foreseen, as Federal Reserve Chairman Ben Bernanke interprets them. [2] Rather, the crisis was caused by "human action and inaction". Their causes were an "enormous failure" of the government and financial supervision as well as a "ruthless risk management" of the money industry. Not only were politicians poorly prepared for the crisis. The risks that have been visible for years have either been ignored or underestimated. Red flags, according to the report, included unethical lending practices, a dramatic rise in household debt and exponential growth in the financial sector, particularly in the unregulated financial derivatives trade.

The Chairman of the Financial Crisis Inquiry Commission Phil Angelides. (& copy picture-alliance / AP)
Since the beginning of the crisis, innumerable reports and analyzes have been written about the causes and consequences of the crisis. [3] The analysts agree: the crisis has many causes. On the other hand, there is no agreement on the weight to be assigned to the individual factors: Was it primarily the unleashed financial markets that plunged the USA and the world economy into one of the deepest crises since the Depression of the 1930s? Is it at the center of an irresponsible policy of the US Federal Reserve, which fueled the turmoil on the financial markets even after the signs of the crisis were long visible? Or was it the US growth model and the high capital inflows into the US from countries like China that made irresponsible lending possible in the first place? There is no simple answer to these questions, and so the report of the US Commission of Inquiry contains two minority opinions in addition to the consensus opinion of the majority. Members appointed to the commission by Republicans in Congress contradicted their Democratic counterparts on one important point. In their opinion, the crisis could not have been avoided even if the American financial system had been more strictly regulated. [4] On the one hand, they emphasize the global imbalances and the associated capital flows into the USA as a decisive cause of the financial crisis, and on the other hand, the government's failed housing policy.

Who is right? It is still too early for a final conclusion. What is certain, however, is that the causes are extremely complex and that the crisis was both a market and a regulatory failure.

Breeding ground for the crisis: glut of liquidity

Ben Bernanke, chairman of the Federal Reserve, at a conference in Washington in April 2012. (& copy picture-alliance / AP)
Two factors created the breeding ground for the economic and financial crisis: the Federal Reserve's expansive monetary policy and the high capital inflows into the USA. After the burst of the New Economy bubble in 2000 and the terrorist attacks of September 11, 2001, the US Federal Reserve (Fed) continued to pursue an expansive monetary policy even when the US economy was already growing again. The reason for this lay not least in jobless recovery: despite the economic recovery, unemployment remained relatively high. Since the Fed, unlike the European Central Bank, has a dual mandate - price stability and full employment - it did not begin to raise interest rates again until the end of 2004, initially very hesitantly. Nevertheless, high unemployment was not the only reason for the lax monetary policy. For a long time, the Fed underestimated the price bubble in the US real estate market, as can be seen from the minutes of the respective years, which the Fed recently published on the Internet. Neither the then Fed chairman, Alan Greenspan, nor his successor, Ben Bernanke, interpreted the signs correctly. In the worst case scenario, Bernanke still expected a "planned decline in the housing market" in May 2006. [5] The export-strong countries such as China and the oil producers of the Near and Middle East, who invested their export income in the USA, also ensured a lot of liquidity in the US market. China alone held US Treasuries worth 618 billion dollars in September 2008 - this figure had increased around eightfold since the beginning of 2000 (March 2000: 74.4 billion dollars). [6]