In a previous post I presented a brief overview of a hybrid monetarist/Austrian view of bubbles and business cycles. This explained the bursting of the ‘agriculture bubble’ in the 70’s. Similar logic would also explain the tech bubble in the 90’s.
The current issue is the recent disruption in the housing market and the sub-prime lending ‘meltdown’ as they are calling it.
By keeping interest rates artificially low for so long- via discretionary monetary policy- resources were devoted to housing at a level that is not supported by fundamentals.
In addition, with low interest rates, the lenders were able to cast their nets much deeper and much wider, getting a large applicant pool with risk characteristics that were unprecedented. Many financial institutions felt that should the house of cards fall, the fed would come to the rescue with liquidity. For this reason risks were taken that otherwise would have been avoided ( this is referred to as a ‘moral hazard’ problem).
After the true fundamentals of the housing market began to materialize, and the bad risks presented themselves with defaults and late payments, chaos ensued.