Research Paper: Housing Crisis and How Its Effected the US Economy

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Housing Crisis

In the mid-2000s, a housing bubble both in the U.S. And in parts of Europe grew and eventually burst. When the bubble burst, housing prices began to fall, putting many homeowners under water. This led to a spike in foreclosures, crippling many financial institutions, particularly in the U.S. The banks involved became unable to lend, leading to a credit crisis that reduced the level of economic activity. Other financial institutions required government bailouts in order to remain solvent. The downturn in the economy had a profound impact on most macroeconomics indicators. Unemployment, GDP, inflation, federal debt levels and other metrics were all severely affected. The bailout plans for the banks, other industries, and the federal government stimulus that followed have also had a long-run impact on the national debt as well. This paper will examine the macroeconomic effects of the housing crisis, with respect to these types of macroeconomic variables.

In order to study the effect of the housing crisis on these variables, the timeline of the housing crisis needs to be understood. Housing starts were in a range around 2 million units from around mid-2003 until early 2006. From that point, housing starts went into gradual decline. By September 2007, housing starts were down to 1.183 million units and dropping. By July 2008 starts were under 1 million in a month, a level it has remained since then. Starts have ranged between 477,000 and 679,000 since November 2008. There is no cutoff point at which the housing crisis can be explicitly determined to have reached the tipping point, but clearly by the fall of 2007 the housing crisis was in full downturn. However, to best understand the impacts of the housing crisis, the assessment of other macroeconomic variables should be made on a peak-to-peak basis. This puts the timeline for analysis as beginning in January 2006.

Gross Domestic Product

Using the quarterly Gross Domestic Product (GDP) statistics from the Bureau of Economic Analysis, it is evident that there is a fairly strong correlation between the decline of the housing market and the decline of the economy as a whole. At the peak of the housing bubble, in the first quarter (Q1) of 2006, the GDP rose 8.6%, which was the highest such increase since 2003. After this peak, however, GDP growth began to decline. By Q4 of 2007, GDP growth was down to 3.8%, and the following quarter GDP growth was at 1%. The major financial crisis hit in September of 2008 with the collapse and near-collapse of a number of major financial institutions. In Q4 of that year, the GDP fell by 7.9%, and remained negative through Q2 of 2009. While the housing market has remained depressed, the economy as a whole has begun to improve, with growth ranging from 3.2% to 4.8% being recorded since Q4 of 2009. This growth, however, can be attributed in part to the stimulus program enacted by the federal government. The 3.2% figure recorded in Q4 of 2010 may be an indication that as stimulus funding runs out, so does economic growth.

Unemployment

The second big story from the housing crisis after the GDP declines has been the sharp increase in the unemployment rate. It should be noted that the official unemployment rate does not include those who have stopped looking for work, which may be a considerable number in the face of sharp recession. Unemployment is a lagging indicator, so it would be expected that unemployment would begin to drop after GDP and only show signs of recovery a quarter or more beyond the broader economic recovery. The Bureau of Labor Statistics keeps unemployment figures.

At the peak in January 2006, the national unemployment rate was at 4.7%. This rate held until December 2007, when it began to climb. The unemployment rate increased steadily through 2008 but the pace of the unemployment increase escalated following September 2008. The rate climbed rapidly from 6.2% in September 2008 to 10.1% in October 2009. The unemployment rate has since declined very slowly, to 8.9% in February 2011. The movement of the unemployment rate in this period essentially mirrors the impact that the housing crisis has had on the economy. The effects have lingered roughly in line with housing starts -- unemployment has not improved significantly from its worst position and still remains at historically high levels.

Inflation

In a recession, inflation would be expected to decline. In particular in this situation, the credit crunch would be expected to suppress business investment. Once the unemployment rate begins to rise, consumer demand will also fall. Reduced demand for goods will naturally lead to overcapacity. This will not only reduce the rate at which prices rise but could also lead to price reductions to clear out the excess inventory. The best inflation figure to use is core inflation, because headline inflation includes highly volatile fuel and food components. For example, fuel prices spiked in early 2008 in a move that was unrelated to the housing crisis and collapsed in the second half of that year as the fuel price bubble burst.

The core CPI in January 2006 was at 202.6 (100 = 1982-84). The core CPI number has increased most months since that point in time, but the rate of increase has changed. For example, in 2006 it was 2.3% and in 2007 core CPI increased 2.1%. In 2008 it increased 1.3%. In 2009 it increased 1.5% and in 2010 it increased 0.7%. These figures indicate that inflation decreased as the result of the housing crisis. The rate for all years subsequent to 2007 is lower than it was for that year. It is interesting to note that 2010 saw a very low core CPI increase of just 0.7%, which is well below the Federal Reserve's inflation target. This is despite an aggressively expansionary monetary policy. The 2009 inflation rate being higher than 2008 may be explained by the effects of the federal stimulus package, while the 2010 decline is indicative of the stimulus running out.

Federal Debt

The federal government's debt can be expected to increase as a result of the housing crisis, for several reasons. The first two relate to fiscal policy. At the height of the banking component of the crisis in September 2008, the Bush government opted for bailouts of the banking industry, ostensibly to prevent the industry from collapsing. The collapse in consumer demand that followed led to addition federal spending with the automaker bailouts and the stimulus package. The third reason to expect an increase in debt is that revenues would decline if the GDP declines and unemployment rises. That corporate profits declined in the face of declining demand would also have contributed to a decline in tax revenues. The Financial Management Service of the Department of the Treasury tracks budget revenues and outlays on a monthly basis. During the 2006-2007 period of slow economic decline, many months saw a surplus, and those months that were in deficit saw a relatively minor deficit. During those two years only three months saw a deficit over $100 million, two in February, and indeed previous years' data shows that steep outlays occur every February. In 2008, six months saw deficits over $100 million. There were seven months in 2009 over this level; and five more in 2010. The last month with a budget surplus was September 2008, the month that the housing crisis hit the banking industry, precipitating TARP. Therefore, when the government first became actively involved in the process of economic recovery, it saw spending deficits in every single month, and far more months of exceptional deficits than were seen previous to the housing crisis.

Conclusions

The housing crisis created a number of negative effects on the American economy. The statistics compiled by various agencies reveal the true impacts that the… [END OF PREVIEW]

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