When Expectations and Insufficient Regulation Converge

The rapid decline in U.S. house prices triggered the most severe global recession since the Great Depression. Speculative bubbles like the house price bubble generally emerge when beliefs in steadily rising asset prices and coordinated behavior of market participants converge.

Externalities in financial markets like informational cascades and payoff-externalities lead to selffulfilling expectations and work as amplifyers. Politics also play a decisive role. An expansive monetary policy and insufficiently regulated financial markets allow cheap borrowing. All of these effects would be reduced if the actors had to stick to responsible lending standards.