When the global financial markets plummeted precipitately, the housing sector bubble burst became the optics center discussion for many market analysts, politicians, economists and many others. However the question is how can homebuyers in North America be in position to nearly derail the financial system within such a short period of time and across the whole spectrum of the financial market and system. The answer is not far fetch when one takes a critical look at the consequences of government interventions either by way of regulations or policies, the activity of market speculators (noise traders) and investors, just to mention a few in a system which is considered to run efficiently.
Over the years, housing sector has seen significant shift in government interventions as an economic tool to boast economy as it has greater and sudden multiplier effects, compared to others which are saddled with greater lag in impacting the economy. The sector has becomes susceptible or common tool for continue government policy tool to influence the economy. This knowledge has become a universal knowledge to all and for most economies in the world. But the irony is that the world's economies has become so much integrated over the years, such that any economic policy or action by one economy creates direct or ripple effects or consequences for others if not all the economies in the world at the same time. It therefore implies that the recent U.S. government action to induce growth in the housing sector to stimulate its economy by pumping more funds into the sector, and the U.S. Federal Reserve Bank, not wanting the market to set exchange rates through the usual arbitrage system set by the market system but cutting interest rates to record-low levels and U.S. politicians by means of legislation, pumping up risk-taking and housing prices further through deductions, tax benefits for home savings accounts, subsidies and government-sponsored enterprises, they managed to generate mortgages even for people that the market deemed uncreditworthy.Other organizations such as Fannie Mae and Freddie Mac with the federal government backing created further securitization of mortgages for sale which turn out to be hot investment items for many financial institutions which scrambled to repackage, replenish and sell mortgage loans with little fundamental values. The Fed's safety net and the federal government's deposit insurance made banks dare to take big risks because they could privatize any gains and socialize any losses.
When home prices began to fall and the market no longer wanted mortgage-backed securities, it began to give rise to waves of panic selling. This, along with other factors, put such a burden on the bank balance sheets that regulations forced them to pile up capital rather than make loans. And just as the markets were worried more than ever because they did not know where the big risks were, U.S. authorities banned shorting, thus depriving the markets of liquidity and information when they needed it most.Ironically similar policies and actions were equally implemented by most developed economies notably Japan, Australia, Canada & Great Britain. These actions collectively overwhelm the capital markets around the globe leading to greater and higher saturating the market .
The markets are set to be rational so that at some point all information are incorporated in decisions making process. Neoclassical economic models which underlay this theory failed to see changes in human behaviour and the economy. The market is all about the millions of participants making decision to produce, act and invest and the slightest introspection is enough to realize that people do not act like the theory models. Since gathering lots of information before making decision takes time and money, people often times go with their gut, follow rules of thumb and copy what others have already done. The market ends up having a herd instinct, moving people in one direction at a point in time and other direction at another point in time. When other arbitragers seem to be successful and getting rich at something, others follow suit. But after a while, the hollowness of the enthusiasm pale off as information eventually become absorbed into the financial system level off any gain and panic and fear set in for many who were unsuccessful resulting in bubble bust or crush.