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The immediate cause of the financial crisis is relatively easily seen. The problem was that a “bubble” occurred in the housing market, causing house prices to increase rapidly and beyond what was warranted. This bubble of inflationary housing prices led to eagerness to participate in the housing market and, thus, the issuing of many bad housing loans. Firms wanted to lend to more and more people. They used creative methods to give mortgages to people who should not have had them. The creation of mortgage-backed securities created a situation in which many financial institutions issued and were exposed to these bad loans. When the bubble popped, meaning mortgages were not met and mortgage securities failed, and the crisis occurred.
The bigger issue is what conditions existed as why the bubble occurred in the first place. This is the subject of great controversy, largely along partisan political lines. Democrats argue that the crisis happened through corporate greed and a lack of regulation. They say that the companies made bad and even unethical loans. They say that the lack of regulation of the financial industry allowed the creation and misuse of the mortgage-backed securities. This, they say, led to the bubble.
Republicans, by contrast, believe that it was excessive government regulation that caused the bubble. They point to efforts by the government to extend home ownership to people with less and less money. This intervention, they say, caused bad mortgages to be made. Federal guarantees caused moral hazard. In these ways, the government inadvertently caused the bubble through regulation.
It is not clear at this point which side is correct.
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