The Fed and the Housing Bubble/Bust

by Robert P. Murphy

In chapter 8 we presented Ludwig von Mises’s circulation credit theory of the trade cycle, or what is nowadays referred to as Austrian business cycle theory. In the present chapter, we will apply the general theory to the specific case of the US housing bubble and bust, which began sometime in the early 2000s and culminated in the financial crisis in the fall of 2008.

In a nutshell, the Austrian narrative recognizes the role that private sector miscreants can play in any particular historical boom but argues that these excesses were fueled by the easy money policy in the early 2000s enacted by then Fed chair Alan Greenspan. By flooding the market with cheap credit that came from the printing press rather than genuine saving, Greenspan pushed interest rates (including mortgage rates) down to artificially low levels. This caused (or at least exacerbated) the bubble in house prices and misallocated too many real resources to the housing sector. When the Fed got cold feet and began gently raising rates from mid-2004 onward, the bubble in house prices eventually tapered off and turned to a crash.

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