Professor Kenneth Ng 4/27/2011 Econ 311 Term Paper #1 Housing Boom and Bust In 1970’s, housing boom occurred in the United State. The number of people who buy a house increased sharply; also housing price surprisingly increased. According to “The Housing Boom and Bust”, Thomas Sowell, median home price increased by one-third, from 143,600 to 219,600. In coastal California, because there is also popularity, median house price increased by more than 100 percent from 2000 to 2005. However, in 2006, housing boom was end. The housing price was dropped, and many people were hit by the collapse of the bubble housing market and especially low income people suffered from this collapse of the housing market. There are several reasons why housing boom occurred and busted. Government regulation, choice by individuals to gamble on increasing housing prices, government promotion of “affordable house”, failure to government regulator to monitor the lending activities of banks and other financial intermediaries, and set of lower interest rate are reasons why housing boom occurred and increasing housing prices. These are five keys how the crises occurred and unfolded. First of all, government regulation increased housing prices shapely. According Thomas Sowell, top ten areas with the biggest home price increasing in previous five years were all in California. In 1970’s, government restricted the use of land by policies and laws. These laws and policies forbade building houses to some places. This regulation makes lack of land to live and drove up the price of the remaining land. In the coastal California, there are severe land use restrictions, and it makes housing prices skyrockets. According to Financial Crisis Inquiry Commission Report, house prices rose 7% per year in Texas which state does not have that sever restriction from 1980 to 1985. In comparison, prices rose 13% annually from 1985to 1990 in California. There is obvious difference between two different states. While this happens in this period, there has been seen difference about their income as well. Average income in Texas increased faster than other states, however, price of the houses did not increase that much. This fact tells that the sever use of the land restriction made house prices skyrocket. Second, gambling for price of the house increased housing prices. During the housing boom, many people could make a profit to buy the houses and sell it after the price goes up to gain margin. Some people gambled by utilizing adjusted rate mortgages (ARMs). Adjusted rate mortgages is the loan that people can receive with variable interest rate, so when the interest rate is low, people borrow at low interest rate, and sell it quickly before the interest rate goes up. Hence participants of this gamble could make remarkable sum of profit, and many people tried to make profit during the housing boom. This movement lead to increase the demand of house and price went up. Third, government promotion of “affordable house” changes the price of houses dramatically. Government wanted to reduce the cost of the house for low income people. The rule of thumb was that housing price should not be more than one-fourth of a family’s income. Sowell said, “In the beginning of 20th century, when government played a much smaller role in the housing markets, the housing cost was smaller (34).” In other words, as government take a bigger role in the market, the price of houses gets higher. Promotion of “affordable housing” tried to reduce the cost of housing, but its policy did not reduce the magnitude of role of government in the housing markets and it caused housing price much higher. Fourth, failure of government regulators to monitor the lending activities of banks and other financial intermediaries increased the house price and caused the housing boom as well. According to the Thomas Sowell, in 2004, adjusted rate mortgages (ARMs) were 35 percent of all mortgages (71). ARMs depend on market interest rate, and during the housing boom, interest rate was low, so many people could receive loan at low interest rate. Because it was low interest rate, it encouraged people to borrow money. Low income people especially African American and Hispanics could receive subprime loan, which is low interest rate at first few years, and after the duration, interest rate increases to regulated rate. Banks and financial intermediaries lend to low income people with high risk. Because of subprime loan, people could buy a house even though they are low income people, and the demand of house is increased and price in the housing market is also increased steeply. Government should have intervened to regulate banks and other financial intermediates to prevent housing price from going up. Finally, fluctuation of interest rate affects housing price and eventually it increased the price. During the housing boom, Federal Reserve System set interest rate low. Because of that, people pay low mortgage payment and it helped demand of house go up. Thus as low of demand tells you, housing price increased. In early years of twenty-first century, interest rate was set low, so that demands of houses increased, and housing price also increased during those years. In conclusion, government regulation, gambling, promotion of “affordable housing”, failure of government regulators, and interest rate are intimately related and caused housing boom and busted. I believe that mainly this complex collapse was caused by government.