Why did the housing bubble arise and then pop in the years after 2001?

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pohnpei397 eNotes educator| Certified Educator

The basic answer to this is that no one knows for sure.  There are many theories, but no one is completely sure.  It would be a good idea for you to check your text book or lecture notes to find out what answer you are expected to give.  Economists cannot easily determine the causes of changes in something so vast and complex as a national economy.

There are two main theories about the formation of the housing bubble.  One of these blames the government.  This is a conservative view of the bubble.  It says that the government did too much to encourage loans to people who really could not afford those loans.  By doing this, the government created more demand than there should have been and housing prices started to shoot up.  In addition, the government kept interest rates too low, which also increased demand for single-family homes.

The other theory blames the private sector.  This is the liberal view.  This view holds that greedy lenders caused the bubble.  The lenders lent too much money out on terms that were unsustainable.  They also pushed the government to leave the market without sufficient regulation.  By doing these things, the private businesses created excessively high prices and a class of borrowers who could not afford their loans.

This bubble popped because bubbles always do.  At some point demand, however inflated, runs out and then a chain reaction occurs, reducing prices and leading to defaults.  This is what happened in 2007 and 2008.