Housing Bubbles And Financial Crisis

The American subprime crisis which took place in 2007 has exercised substantial negative impact on global financial system and exposed many serious weaknesses of financial markets and financial regulation in developed countries.The research purpose of this paper is to 1) summarize thoroughly the existent theory upon housing bubbles and the relationship between housing bubbles and financial crisis in the backgroud of turbulent global financial system and to 2) make some methodological innovations and progress on certain important theoretic problems,such as risk analysis of residential mortgages,test and calibration of housing bubbles,explanation of chinese housing bubbles,mechanism of asset bubble formation,explanation of modern banking crisis,explanation of the relationship between asset bubbles and financial crisis and the strategy by central bank to address asset bubbles.At the same time this paper proposes valuable guidelines for the healthy development of chinese housing finance and housing market and the steady operation of chinese financial system.The major work and findings of this paper are as follows:The observations and review of 2007-2009 American financial crises.The major formation mechanism of American housing bubbles and financial crisis are proposed.The housing bubbles,credit inflation,securitization market disorder and rampant high-risk credit products are interrelated and mutually reinforced,which have caused the irrational exuberance of American economy.But while asset bubbles burst and asset prices plummeted,it will cause lage-scale high risk credit products'defaults,devalue asset-backed securities and credit crunch,which in turn drive asset prices further down,causing serious financial crisis and recessions. So housing markets,credit markets,money markets and securitization markets form a economic system which has the property of procyclicality and positive feedback.This system is apt to magnify the outside shocks and possess inborn instability and fragility.In the light of experience and lesson from American subprime crisis the suggestions on how to undertake financial supervision reform, develop derivatives market and push on diversification of financial institutions in china are also advanced.This paper uses a real options approach to analyse default behavior of residential mortgage borrowers, mainly on the optimal default exercise frontier of the mortages. Thus we can expound what house price and interest rate combination will trigger default and calculate default probability.We find default frontier depend strongly on spot interest rates and have a close connection with loan types.We investigate the situations of suboptimal termination and situations under which borrowers face stigma costs. The research in this paper gives us deeper and objective understanding of current subprime crisis in the U.S..We also construct a general model, which considers the borrower's termination behavior, to derive the closed-form formula of the mortgage value. Since the risks of prepayment and default are reasonably expounded in our model, our formulae are more appropriate than traditional mortgage formulae. Our model provides portfolio managers a useful framework to more appropriately appraise the mortgage and more effectively hedge their mortgage holdings. From the results of sensitivity analyses, we find that higher interest rate, prepayment and default risks will increase the mortgage yield and reduce the duration and convexity of the mortgage.A time-varying present value approach is used to estimate the fundamental value and bubbles of chinese housing from the perspective of real income and real rent.From the angle of real income there exists weak negative bubbles in chinese housing which means current housing prices are undervalued and chinese housing prices will continue to go up to converge to its fundamental values.But from the angle of real rent there exists remarkable positive bubbles in chinese housing which means chinese housing prices will collapse to return to its fundamental values because they are overvalued.And because housing prices and rents are of bidirectional Granger causality,it is possible housing prices push rents up to recover the long-time consistency of two time series.Panel data econometric methods are also used to verify housing bubbles in china.The relationships between asset bubbles and financial crisis are analysed. That asset prices and monetary policy can have an effect on financial stability in two ways is argued.The first is that when there is an agency problem between banks and borrowers who make investment decisions asset prices can rise above their fundamental.The agency problem means that investors choose riskier projects and bid up prices.The greater the risk the larger the bubble.It is not only the risk that is associated with the uncertainties of asset returns that can cause a bubble but also the financial risk associated with the uncertainties of monetary policies and paticularly financial liberalization.The second problem occurs when asset prices fall.If this fall causes banks to liquidate assets simultaneously then asset prices can fall below their fundamental value.This negative bubble can be very damaging.The modern central bank has a complicated task to prevent both types of bubbles.The relationship between asset bubbles and monetary policy are probed into.This paper extends the conventional monetary rule model by introducing timing effect of investment and fluctuations of asset prices. The result shows enterprises are sensitive with interest rate and interest rate leverage has become more and more power on macro-economy. The inefficiency of China monetary policy is most likely due to neglect of investment timing effect and asset price fluctuations when china central bank is setting interest rate policy, which results to systematic insufficient response to macroeconomic variables. So when setting interest rate goal China central bank should take into account timing effect of investment and fluctuations of asset prices and keep a close watch on expectations and confidence of public and firms on central bank monetary policy effect and take measures to build up public confidence on monetary policy effect to get an optimal effect of macroeconomic tune-up and control.