The United States experienced the worst form of financial crisis in the last months of 2008 after the great depression that was experienced in the period around 1929-1930. The crisis was caused by a problem in the housing sector. The federal government encouraged banks to offer mortgages to people who had not met the requirements for receiving a loan and that was a risk to the banks. In 2008, most banks started declaring losses that originated from the bank customers defaulting to pay their mortgages. The United States experienced inflation that had not been expected and that was a contributor to the financial crisis in the country. Every bank has a credit department that is involved in ensuring that loans are extended to eligible persons only. In 2008, the federal government wanted to help the poor people in the country by lobbying with the financial institutions to extend their loan facilities to the people who had not qualified for the loan facilities. The country had predicted a high demand for housing, but they had not foreseen the issue of inflation.
The high demand for housing increased the demand for mortgages from banks. The individuals who were seeking the loans could not foresee any negative implications that could have been caused by inflation. This is in line with the things that were learnt in class. In class, we learnt that a bubble in the housing sector is caused by extremely high expectations in gains that accrue from housing. If the consumers expect high gains without factoring in inflation, then the consumers assume that the interest rate will not be changed by any factors. The cost to the users falls because of the unchanged interest rates and that increases the level of demand amongst the various consumers. According to the forces of demand, the increase in demand leads to an increase in the price of a commodity and in this situation, the commodity will be housing sector. The increase in the prices further increases the anticipated gain from the owners of the facilities. The anticipated demand increases demand and that led to the bubble. The increase in the demand with unexpected changes in interest rates will lead to further increase in demand. The banks were also responsible for the housing bubble because they offered loans at a very affordable rate.
If bank loans are affordable, then it implies that many people will be willing to access the loan facilities from the banks. In a case whereby the banks are extending loans to people in the same industry, then the customers in the industry would be at an indifference point in trying to determine the place they will make their purchase. If the supply is more than the demand, then the suppliers will try to negotiate for a low cost so that they can get some income. However, some will lose entirely. In such a case, the banks will also be at a loss. The banks will lose out when the people who received the loans are not able to service their loan facilities. When the loans are not serviced, then the entire economy is likely to collapse and that would have to take great intervention for the issue to be resolved.
In class, we were able to learn about the traditional approach that is used in the housing sector. The approach is one in which the demand in the housing sector is assumed to be measured in a uni-dimensional manner. The measure refers to a single number. That is a case whereby the floor space is used in measuring the demand. The approach may fail to be accurate in the measurement because it depends on a number of assumptions that may not be scientifically correct. The wrong assumptions could be a mistake that was applied before the emergence of the housing crisis. The housing crisis suffered because of the fact that the supply of houses was greater than the demand. The great supply led to unattended supply and that was the cause of the bubble. The traditional approach in the measurement of supply can be associated with such challenges.
The hedonic approach is the other approach that is used in the measurement of housing. The hedonic approach is different from the traditional approach because it recognizes that housing is not dependent on one variable only (Bruckner 126). The hedonic approach considers a number of factors that are used in the measurement of the housing demand. With the use of the approach, it would be possible for the government to have diverted the housing crisis of 2008. The crisis was based on over ambition by both the government and the banks that were offering the mortgages. At the start of 2008, Citi Bank made an announcement of a large profit that was associated with the issuing of Loans to housing developers and mortgages. The federal government tried to encourage other banks to offer loans so that they can benefit from the high demand amongst the citizens of the country. In that case banks started offering mortgages and that was the start of the crisis. Banks reported large losses and the effect was not recoverable within a short period. If the hedonic approach were used in the determination of the housing demand in the United States, the country would have been able to determine the level that would have been enough to avoid any form of loss. The banks would also have been able to determine the rates that they are supposed to offer to the clients.
Increase in demand is caused by low interest rates. If the banks used the hedonic approach in the measurement of demand, the country would have been able to determine the interest rates that would be applied in the borrowing. Higher interest rates would have regulated the demand for mortgages and that would have ensured that the bubble was not blown. Therefore, the U.S. authorities failed to control the interest rates, thereby facilitating the occurrence of the crisis.
All in all, macroeconomic items in a country are crucial to the economy of a country. A country should be able to monitor periodically its economic state to ensure that any potential crisis is detected early and diverted. In the case of the housing crisis, the issue could have been diverted if the interest rates were increased early. That would have reduced the demand and the damage caused by the crisis could not have been felt by the economy. A country should also factor demand and supply forces and a macroeconomic factor such as interest rates when making critical economic decisions.
Brueckner, Jan K. Lectures on urban economics. MIT Press, 2011.