Housing Bubble

Question 1

What are the 2 main contributing factors to Rising house prices?

Answer 1

Physical Barriers to Expansion

Median Family Income

Question 2

How do Physical Barriers to expansion affect house prices?

Answer 2

Result in INELASTIC SUPPLY in the S/M Run

Question 3

How do Median Incomes affect House prices?

Answer 3

Rising Incomes–> Increased DEMAND for housing

Question 4

What other factor, besides median incomes + physical barriers, can increase house prices?

Answer 4

Population Growth

Question 5

Draw the Supply + Demand diagram for a housing bubble

Answer 5

Perfectly Inelastic SR Supply
Perfectly Elastic LR Supply
Downward sloping Demand curves
Demand Shifts to the RIGHT to show Bubble Demand

Question 6

Define Mortgage

Answer 6

Payment scheme designed to bring the original debt used to buy a house to Zero over a period of time

Question 7

What Association in the USA Securitised Mortgages?

Answer 7

Federal National Mortgage Association- Fannie Mae

FNMA

Question 8

What did Banks sell to FNMA? And what did FNMA do with these products?

Answer 8

Banks sold Mortgages
FNMA bundled Mortgages together to create Geographically diverse products–> Low Risk–> Investors bought Bundles–> Reduced Mortgage rates–> Increased Affordability

Question 9

What are the 2 types of Mortgages that increased House Prices further?

Answer 9

Interest-only Mortgages
Negative-amortisation Mortgages
Buyers may not have understood terms of these mortgages- increased overall cost of mortgage despite offering initially lower monthly payment cost

Question 10

What 5 factors caused the Housing bubble?

Answer 10

Expectations
Banks did not own Mortgages
'Liar Loans'
Technology
Credit Default Swaps (CDS)

Question 11

How did Expectations contribute to the Bubble?

Answer 11

People expect prices to Rise in future–> Buy Assets Now–> Increases Demand–> Expect to Sell later at higher price

Question 12

Why didn’t Banks own the mortgages + why was it an issue?

Answer 12

The Mortgages were sold together as bundles days after being written-off
Issue because when people defaulted, Banks had houses but no liquid assets to pay back Investors

Question 13

What are Liar Loans?

Answer 13

Negative-amortisation loans sold without the Bankers verification of Borrowers Income/Assets
-Only consulted Credit-rating agencies

Question 14

What was Technology’s role in the Bubble?

Answer 14

Mortgage application automated online- easier to apply + get a Mortgage

Question 15

What are Credit Default Swaps (CDS)?

Answer 15

Insurance on Mortgage-backed securities (MBS) in case borrowers’ default
Eased Investors concerns- kept bubble going
CDS was not regulated as Insurance policies
Due to growing economy, everyone was too happy to be concerned w/ CDS

Question 16

What happened when the Bubble BURST?

Answer 16

House Valuations DECREASED
Borrowers Default on Mortgages
Bank repossess house/Borrower sells house but does not cover Mortgage due to Lower House Price
Bank Loses out
Bank goes BUST

Question 17

What was the effect of the Housing bubble bursting on the overall economy?

Answer 17

Late 2007- Bubble impact snowballed- Securitised Mortgages’ value in Doubt–> became apparent in 2008- Lehman Brothers collapse

Question 18

What measures did the US Gov. take to prevent massive Financial meltdown?

Answer 18

1. Took ownership in lenders/banks- Took equity stakes in US financial institutions in exchange for Capital
2. Nationalisation- US Treasury took Ownership of Fannie Mae + Freddie Mac
   - Federal Reserve took a stake in AIG- Insurance firm
3. Toxic-asset Purchases- Fed Reserve removed some Toxic Assets (Securitised Mortgages) from Banks’ balance sheets