I'll put a tl;dr at bottom
I've often made a point of differentiating the causality of the financial crisis and the Great Recession, but there's another aspect of the recent downturn that I haven't really dealt with. The housing bubble--that is, the rapid decline in appreciating house prices which occurred (in the U.S.) in 2006.
Often, the argument goes that the Federal Reserve kept interest rates in the economy too low for too long, and promoted a climate of risk-taking an over-activity in the economy. It makes intuitive sense--low interest rates bring new players into the market who then begin constructing houses in order to meet a temporary increase in demand. Eventually, a rise in interest rates or a sharp decrease in lending will pop the bubble.
There's not really any evidence to suggest over-ambitious house-building projects in the 1990s-2005. Housing construction appears to be cyclical on a graph, but this was broken during the aforementioned period and saw a continuous increase in new construction projects for fifteen years. Now, this
would be suspect, were it not in line with population growth:
As for prices themselves? The activity differs so much across the states that it's difficult to say. The grey area on the graph is when the interest rate was supposedly held too low by the Fed from 2002 to 2004:
On top of this, the Case-Shiller Index for house prices quite clearly shows a run-up in prices beginning in the late 1990s, which didn't pick up during the period of low interest rates:
The problem, too, with using interest rates as a view for monetary policy is that
it isn't reliable. It's true that the federal funds rate (the rate that the central bank directly controls) was very low between 2002-2004, but as we can see in the graph below, nominal income was recovering from something of a shortfall. Monetary policy over that two-year period was, essentially, exactly correct:
The problem was long-term real interest rates. As we can see in the graphs below, rates on ten-year treasury bonds closely followed the fed funds rate, however this changed after 1990 and the two rates essentially 'unhinged':
There are a number of explanations for this, including the one I find somewhat convincing--Bernanke's Global Savings Glut hypothesis. This has garnered support from
Alan Greenspan who agrees that the rise in housing prices was probably caused by a decline in long-term rates which the central bank had no control over. And, indeed, looking at several other countries we can see that rising house prices was an almost
global phenomenon. House prices were a little different in America, in that they peaked two years before the global downturn, but when you look at the
data then it's clear global house prices plunged in 2008-2009 when worldwide nominal income bit the bullet.
But what really matters about all this is that
it doesn't matter. The housing bubble, at least in 2006 and in the U.S., really is immaterial to the whole discussion. Following the--roughly--50pc decline in house prices come 2006,
unemployment didn't shift. It wasn't until mid-2008 to mid-2009 that unemployment
really picked up. . . right as global nominal income tanked, and just before the financial crisis.
The idea that the housing bust made investors skittish is probably correct, but still immaterial. BNP Paribas seized up some of its activity prior to the Recession in Dec. 2007, about a year before Lehman Brothers failed, but history has shown us that
credit crunches don't matter. TL;DR:
Spoiler
>people blame low interest rates for the housing boom
>the idea of a housing boom isn't even a solid one
>interest rates were decoupled in the 1990s, the fed couldn't do anything about it
>global house prices faced a similar run-up, it was a global phenomenon
>global house prices fell when nominal income fell
>poor nominal income is a sign of poor monetary policy
>we need to focus on central bankers' responsibility with the recession, not the fall in housing prices
The housing bubble really was irrelevant