Causes Of Financial Crisis And Household Bubble

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Causes of Financial Crisis and Household Bubble

Essentially, financial crisis and housing bubble have a close relationship. Notably, the

financial crisis occurs when the demand for money is greater than the supply. On the other hand,

the housing bubble refers to the rising in the prices of the houses because of demand, and the

speculations of the future shortages. Ideally, when there is financial crisis, most of the asset loses

their nominal value (Engsted, 67). Studies reveal that the financial crisis in the USA that was

experience in 2007 and 2008 was a consequent of the following factors; banking panics, stock

market crash, other financial bubbles such as currency crisis and the sovereignty default.

Conspicuously, the financial crisis does not affect the economy either positively or negatively

but cause the loss in the paper wealth. This paper seeks to explain the causes financial crisis and

house bubble in the USA.

Primarily, many factors contribute to the financial crisis. The factors comprise of assets-

liability mismatch, uncertainty herd behavior, regulatory failures, Leverage, contagion,

recessionary effects, and the strategic complementarities markets. Notably, Leverage involves

borrowing more money from financial institutions for investments (Engsted, 68). Most financial

institutions believe that if they invest their own money, it becomes risky and may result in a loss

in the end. However, these institutions borrow more to boost the amount of money in the

investment. In this case, the borrowing firm hopes to earn more returns from the investment in

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proportion to the amount invested. As a result, the huge borrowing by firms makes it hard to pay

all its debts thus spreading the financial troubles to other firms.

Moreover, asset-liability mismatch is a factor that most financial analyst believes in

causing financial crisis. Notably, asset-liability mismatch occurs in banks when they fail to

match the short-term withdrawals by the depositors and the long-term loans that they give to the

clients. However, sometimes banks give long-term loans to the customers from the short-term

savings from the account holders (Engsted, 69). Assets-liability mismatch of this kind causes

bank runs thus transferring financial problems to the account holders.

Contagion refers to the possibility of the financial crisis to spread from one financial

institution to the other. For instance, when a bank is experiencing bank run, the effect is spread to

small other banks, or from one country to another (Engsted, 69).Other risks that are believed to

transfer financial crisis are the currency crisis, sovereign default, and the stock market crashes

spread across countries.

Moreover, recessionary effects are both the result of the financial crisis and the cause of

the financial crisis. Notably, there is a positive relationship between a condition of financial

crisis and recession. For instance, when a country is experiencing the financial crisis, there is

little or no money to finance the key sectors of the economy. As a result, the economy will

stagnate hence economic recession. On the other hand, when the country is at recession means

that there is no money to initiate the economic projects hence the recession affects causes’

financial crisis.

Regulatory failure gives a good environment for the excessive financial risk by the financial

institutions (Engsted, 70). Ideally, the purpose regulations are to ensure transparency in the

organization through publications of the financial records. Another objective of regulations is to

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ensure that institutions have enough assets to that can help them meet their financial obligations.

This is achievable through reserve requirement, capital requirement and the predetermine limits

of Leverage. However, when there is government failure in regulating institutions, there will be a

risk of financial crisis. Organizations will seek for financial aid through loans beyond their

capabilities to pay. There in capabilities to pay the debt transfers the financial crisis across other

institutions.

On the other hand, house the bubble occurs when the prices of the home rise beyond the

expected rates. Notably, the wealthy people may predict future shortages in the supply of home

and thus buy the existing homes to anticipate the rising demand. Other companies and persons

may have the same idea of purchasing the existing homes. This scenario will push the prices of

the home beyond the normal prices. In the same way, the increase in the number of people

looking for a home to buy leads to a decrease in the number of home in relations to the number

of buyers. Essentially, the following factors that cause housing bubble in the United States.

Housing tax policy is one of the many causes of the housing bubble. In 1997, the government of

the United States established the tax relief act. The act excluded the capital gains from the sale

home from the from taxations (Engsted, 78). As a result, the people got motivated to buy

expensive homes, fully mortgage homes, second homes and investment in properties that were

more attractive than other investment opportunities. Consequently, the increased demand for the

prices of the home increased thus the house bubbles in the United States.

Moreover, deregulation is another factor that causing the housing bubble. Rationally all the

banks and other financial institutions in the United States were greatly regulated. The regulations

prevented the banking institutions from the giving out loans beyond some the stated limit and

adjustable mortgage loan (Ling, 338). With deregulations of the operations of the banks left with

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them with autonomy to give loans and an adjustable mortgage loan. The deregulations resulted in

the adjustable mortgage loans thus people took the loan and bought home. The financial ability

of the citizen to buy home caused the demand of house to increase. Notably, the increase in the

demand for the house plus the financial strength of the citizens’ result in the housing bubble.

Additionally, reckless government policies and the attempt to make housing affordable

in the United States contributed to the housing bubble. The housing and community act of 1992

allowed all the citizens of United States to acquire mortgage loans with ease money lending fi

institutions under comparatively low-interest rates (Ling, 337). Moreover, the act removed the

many complications were initially followed by the citizens in acquiring the mortgage loan. The

accessibility of affordable loans attracted many people to go for the loans for buying homes.

Consequently, the demand for houses increased thus their prices became high hence housing

bubbles. Additionally, the housing and the community development act made the taking of loans

by the citizens mandatory. The act thus gave the majority of the people financial strength hence

further resulted in the housing bubbles.

The low-interest rate in the United States remained low between 2001 and 2002 for long.

As a result, the repayment of mortgage loans was too low as well. During the time of low-

interest rates, people took a lot risk and took mortgage loans (Ling, 330). Notably, during this

time many people took a loan to buy a home thus creating an increased in the demand for the

houses. Consequently, the increase in the demand caused the increase in the prices of the home

than other periods. However, with the financial abilities of most people, the demand for the

house further increased thus causing house bubbles.

Notably, to reduce the housing bubble that existed when the low interests, the government raised

the interest rates. The increase in the interest rates in effect made the acquisitions of home

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expensive for most citizens (Ling, 328). Consequently, the rise in the interest rates resulted in the

limited circulations of money in the economy. As a result, the country experienced economic

recession hence appreciation in the prices of homes.

During the time of house bubbles, the government provided an incentive to the people to

enable them to buy a home. The incentives were in the form of lowering the interest rates on the

mortgage loans and making the loans mandatory for all the citizens (Ling, 327). The financial

status of the people was improved by the easy access of the loans hence demanded homes to buy.

Additionally, there was an increased in the supply of money in the economy thus the experience

economy growth. As a result, most of the people acquired home at higher prices because of the

financial strength. In effect, there was a housing bubble in the country.

`Notably, the economic strength of the people prompted the house buying behavior.

Studies reveal that the behavior of uncontrolled house buying is not the actual habits of the

citizens, and thus the nation often experience recession and the house bubbles (Ling, 325).

Notably, the effects of the housing bubble and the financial crisis in the country resulted in the

citizens acknowledging their contributions in the house bubbles.

In conclusions, house bubbles and the financial crisis are generated by the poor

economics decisions. The increases in the government incentives through mandated loans and

the decrease in the mortgage interest rates are causes of the house bubbles. The reductions in the

government expenditures and the restrictions on loans to the members of public reduce the

circulations of money in the economy. Deductively, the major causes of the financial crisis are

contagion, asset-liability mismatch, failure in the government regulations and the recession

effects.

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Works cited

Ling, G. U. A. N., and G. E. Yang. "Housing Bubbles and Urban Population Growth." Research

on Economics and Management 12 (2012): 008.( 324-345)

Engsted, T., S. J. Hviid, and T. Q. Pedersen. "Explosive bubbles in house prices." Evidence from

the OECD countries (2014). 67-80

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