How an Economy Grows and Why It Crashes

H O W   A N   E C O N O M Y   G R O W S   A N D   W H Y   I T   C R A S H E S
I
t’s hard to overstate the impact the housing boom 
made on the economy as a whole. During the height 
of the mania, the fi nancing, construction, and furnishing of 
homes had become the central dynamo of the U.S. economy. 
And while everyone acknowledged the good fortune, few 
spared much concern about the future costs. 
In addition to the profi ts made by real estate “fl ippers” 
(those who serially bought and sold properties), homeowners 
extracted hundreds of billions of dollars per year from 
their homes. The process turned houses into tax-free ATM 
machines. People used the money to renovate their homes, 
take vacations, pay for college, buy cars and electronics, and 
just generally live better than they would have if their homes 
had not appreciated in value. 
But the wealth was simply a mirage. 
In his book Irrational Exuberance economist Robert Shiller 
determined that in the 100 years between 1900 and 2000, 
home prices in the United States increased by an average of 
3.4 percent per year (which is just slightly higher than the 
average rate of infl ation). There were good reasons for this. 
Prices were fi rmly tied to people’s ability to pay, which is a 
function of income and credit availability.
But from 1997 to 2006 national home prices gained an 
astounding 19.4 percent per year on average. Over that time 
incomes barely budged. So why could people pay so much? 
The difference was credit, which government policy made