1. The Federal Reserve cut interest rates to as low as 1% so that after inflation we had negative interest rates.
2. As a result, mortgage rates fell to an all time low.
3. Low rates caused borrowing and lending to explode, particularly in real estate. For example, commercial banks more than doubled the amount of real-estate loans they made.
4. All these low interest loans had to be extended to people with worse credit ratings and this increased the demand for homes and other real-estate assets. It should not be surprising that home prices skyrocketed. Click on the link below to the Real Estate Roller Coaster:
3 min 42 sec
Fannie Mae, Freddie Mac, mortgage-backed securities, and credit derivatives were simply the conduit that made all these bad loans and investments seem less risky than they really were. In this manner the Federal Reserve can fool the market, at least temporarily. In the end the market always reasserts itself.
Mark Thornton is a senior resident fellow at the Ludwig von Mises Institute in Auburn, Alabama, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is coauthor of Tariffs, Blockades, and Inflation: The Economics of the Civil War and editor of The Quotable Mises and The Bastiat Collection. Comment on the blog.