331
See also: Boom and bust 78–79 ■ Economic bubbles 98–99 ■ Supply and
demand 108–13 ■ Testing economic theories 170 ■ Financial crises 296–301
CONTEMPORARY ECONOMICS
that the value of their houses will
rise. This confidence rises in step
with an improving economy. As
residential sales begin to return to
a normal level, residential investment
increases, providing jobs and further
fueling a return to economic growth.
Economists have analyzed the
relationship between the housing
market and the overall economy
and believe that by studying the
levels of investment in housing, it
is possible to accurately forecast
recessions and recoveries. In their
2006 book Housing Prices and
the Macroeconomy, British
economists Charles Goodheart
Residential investment is halted, and jobs in associated industries
are lost. House prices stagnate, and the wider economy falters.As the economy grows, more people feel
confident enough to purchase a house.This increased demand leads to a rise in house prices.
House builders invest in further building.Prices reach an unsustainable level
and demand stagnates.The housing market mirrors boom and bust.
Irresponsible lending
in the housing marketThe economic crash of 2008
owed much to the liberalization
of the mortgage market and
irresponsible lending by
banks. At first, lenders
enforced strict requirements
on borrowers, lending only to
those who could cover both
the interest and repayments
on the base amount that had
been lent. However, as the
economy improved, mortgages
were offered to those who
could afford to pay only the
interest payments. These
people were relying on an
increase in their income or in
the price of their home to pay
off the balance of their loan.
In the US lenders then
began to offer mortgages
to people who did not earn
enough even to cover the
interest payments—these
loans could only be serviced
with strong growth in house
prices and income. When
the economy faltered and
borrowers began to fail to
pay back their loans, the
whole economy collapsed.and Boris Hofmann showed that
there is a correlation between
economic performance and housing
prices. They claim that by following
appropriate policies in the future,
it should be possible to strongly
mitigate, or even avoid, the worst
effects of a recession.
Unfortunately, this was not the
case with the housing “bubble”
that burst in the US in 2008. Here,
rapid financial innovations created
instability in mortgage financing
that led to unwarranted consumer
confidence and an unsustainable
boom. The housing market was the
cause of the eventual bust. ■During the wave of bank
foreclosures that followed the 2008
financial crisis, boarded up homes
such as this one in New Jersey
became a common sight.