Running head: HOUSE MARKET CRASH LITERATURE REVIEW

Literature Review; Crash of the House Market

Leading to the Great Recession

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Introduction

Following the 2008 "Great Recession," homebuilding experienced a time unlike any

other financial slump. Over the years, the market deteriorated for dozens of skilled local

homebuilders. Their collapse had catastrophic economic, social, and employment consequences

and repercussions for lenders, suppliers, and subcontractors. While the symptoms and causes of

company failure have been widely researched, surprisingly little analysis has been conducted on

the non-financial variables such as actions, omissions, and traits that contribute to housebuilder

business failures. This includes those due to the failing companies' leadership and management

during the harshest period of the housing crisis.

As a consequence, the purpose of this literature review gathers information that will

contribute to filling a knowledge gap regarding non-financial variables affecting local

homebuilders. Additionally, the research aims to uncover particular methods that builders may

implement into their business models to help them weather difficult economic times. Finally,

these methods are intended to shield these businesses from the detrimental impacts of recessions,

enabling them to flourish in their aftermath. However, the research starts with the backdrop of

the homebuilders' companies failing in 2008, the fall of the housing bubble, and the subsequent

recession.

This research is primarily concerned with the following critical issue.What causes led to

the creation of the housing market, as well as how these elements lead to the housing market's

collapse. Numerous causes contributed to the rise in home prices, resulting in a huge housing

bubble. Due to the study's difficulty and depth, I have concentrated on the impacts of the
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following points: national money and property laws, the financial sector, housing construction,

sub-prime lending, and quality and loaning criteria.

Government Monetary and Housing Policies

Several studies report that the expansion would not have taken place if mortgage

loans had not been made more readily available to potential homeowners due to policies similar

to these. According to the Banking System, brief borrowing costs were reduced after the marker

bubble burst, the 2000 crisis, the 2001 financial ruin, and the 11 September 2001 attacks (Engel

& McCoy, 2016). In 2004, the Federal Funds rate continued to rise gradually. According to the

experts, this decision resulted in a 10% increase in house prices nationally. According to

(Ritholtz, 2011), the Federal Reserve's policy of cheap brief interest rates decreased the return on

local and treasury bonds, compelling investment firms to seek other alternatives. Home loan

securities with a greater return were desirable.

Additionally, It emphasizedHUD's massive push for homeownership (Engel &

McCoy, 2016).As a result, African Americans and people with low incomes were consequently

put under more pressure to borrow from government-sponsored enterprises (GSEs)."The Bush

Administration promoted subprime lending as the primary driver of homeownership growth"

(Engel & McCoy, 2016). Furthermore, the scholars claim that when housing problems are

discovered quickly, state agents and legislators fail to intervene. Market forces will resolve issues

regarding mortgage lending, according to officials. In comparison to other capital assets, owning

a house was an attractive investment. According to, Glass-Steagall was abolished in 1998.

(Ritholtz, 2011). The 1933 law protected the financial system by separating banks from hybrid

funds and private lenders. Increasing bank risk-taking and entering "new" mortgage lending

markets was allowed by the amendment, which fueled the housing bubble.
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The System of Shadow Banking

In the late 1990s and early 2000s, many foreign investors seeking safe assets flocked to

the US financial system. Demand for government bonds increased, resulting in rate reductions.

Because the government maintained low, relatively brief interest rates following the 2000 slump,

Stock Market needed higher-yielding assets for these foreign investors. Those seeking high

returns on their investments found Wall Street to be an ideal place. Fannie Mae and Freddie Mac

are two government-sponsored enterprises that have long utilized securitization to fund home

loans. Taking advantage of the opportunity, highly leveraged entrepreneurs established

themselves as non-bank lenders specializing in home financing. By 2006, private underwriters

had granted a cumulative of 12 million hedge funds totaling $2 trillion. (Zywicki & Okolski,

2009) (Ritholtz, 2011) attributes the crisis to an deregulated "shadow banking sector."

Investment bankers and Hedge funds packaged and marketed collateralized debt obligations

comprised billions of mortgages, thus inflating the housing bubble. (Zandi, 2008) established

that mortgage securitization decreased lending and underwriting requirements. Additionally, he

discovered that collateralized credit had a higher bankruptcy risk when lending standards were

expanded into substandard metro areas than bank portfolio credit.

Lending Products and Standards of Underwriting

Personal loans required new assets to refuel its voracious lending machines. As a result,

they expanded their reach by providing unconventional financing and relaxing screening and

lending standards. Down payment, a phrase coined to refer to lending to clients with poor credit

has now become a widely used term by many lenders. By 2008, subprime and exotic mortgage

debt had reached a combined amount of $2 trillion (Engel & McCoy, 2016). Reduced home
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equity lines allowed customers to borrow money against their homes while values increased,

erasing whatever equity they had built up over time. Demand and prices increased as a result of

new entrants lured by rising expenses and loose mortgage underwriting standards. They

anticipate the next gold rush.

Reduced mortgage criteria were a consequence of government efforts targeted at boosting

low-income homeownership rates, according to (Holt, 2009). To comply with the CRA, lenders

reduced their underwriting standards. Additionally, Freddie and Fannie responded to HUD's

requests by lowering their revenue and interest amount requirements. According to (Bianco,

2008), lax mortgage regulations created a "moral hazard" effect since each participant in the

mortgage transaction benefited and re-transferred. She used the Home Mortgage Disclosure Act's

reduction in conventional loan rejection rates during the boom to bolster her case.

The Subprime Mortgage Market

Subprime mortgage financing started in 1980 as a result of the Financial Organisations

and Fiscal Control Act. As a consequence, banks levied borrowing costs following the inherent

risks. Banks increased interest rates and surcharges on some types of loans and occasionally

demanded credit insurances. Initially, subprime financing favored refinances over new home

purchases. Early home mortgages aided householders in managing and paying personal debts

while maximizing tax deductions on mortgage interest. The subprime market was fueled by

technology, government policy, and mortgage securitization. By 2006, 20percent of most

mortgages originated, and 25% of loans collateralized were subprime, mostly with

overwhelming bulk backed by unregulated lending institutions (Zywicki & Okolski, 2009).

Many of them were charged due to the severity of the recession and the kind of complex

loans provided by some unscrupulous sub-prime creditors. However, their data indicated that
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sub-prime borrowers accounted for less than 20 percent of the market, whereas prime borrowers

accounted for 60% or more. When home prices fell by 40% to 50% in certain regions, many

prime borrowers ditched house payments, still after placing a 10% or 20% earnest money. With

the rate of Unemployment being on the horizon, many borrowers resorted to sending their house

keys to their creditors, leading to a default. Financially stable individuals who persuaded

themselves that the worth of their houses would never fall fueled the real estate bubble.

Conclusion

According to all considerations, the devastating collapse of the housing market was just a

severe corrective measure. The laws of supply and demand apply to all commodities sold on the

open market. Homeowners, investors, state directives, the GSEs, Corporate America, financial

institutions, and other private enterprise players all contributed to creating the housing bubble.

The fast rise in the value of real estate proved to be unsustainable. Furthermore, there is little

doubt that some participants in the mortgage business participated in deceptive tactics that

caused a great deal of distress to many individuals. In the perspective of the bubble's deflating,

their impact was negligibly little. In uncertain markets, the propensity of builders to herd

together resulted in some overbuilding. They decided to ignore signs of deteriorating economic

conditions and instead depend on positive signals from competent competitors. The fact that the

rating agencies ceased to evaluate properly the menace related to these assets where such assets

would have caused investors to reconsider their purchases. The creation of new investment

vehicles, some analysts believe, would have helped to fuel the housing bubble if such a move

had been made.

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References

Bianco, K. M. (2008). The subprime lending crisis: Causes and effects of the mortgage

meltdown. New York: CCH, Wolters Kluwer Law & Business.

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Engel, K. C., and McCoy, P.A. (2016). The subprime virus: Reckless credit, regulatory failure,

and next steps. Oxford University Press.

Holt, J. 2009). "A summary of the primary causes of the housing bubble and the resulting credit

crisis: A non-technical paper." The Journal of Business Inquiry, 120-129.

Ritholtz, B. (2011). Examining the big lie: How the facts of the economic crisis stack up.

Washington Post, 19 November. Retrieved from http://ritholtz.com/2011/11/examining-

the-big-lie-how-the- facts-of-the-economiccrisis-stack-up/

Zandi, M. (2008). Financial shock: A 360o look at the subprime mortgage implosion, and how to

avoid the next financial crisis. FT Press.

Zywicki, T., & Okolski, G. (2009). The housing market crash. Mercatus Center, George Mason

University
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