1. The Fed lowered rates too low and kept them there too long. From 2002 to 2004 (three years inclusive) the Fed Funds rate was below 2%. This encouraged home builders to over-build and also encouraged home buyers using ARMs. The low rates also trashed the dollar, which fell by 30% during thistime against our major trading partners' currencies. This encouraged an inflation mentality. People piled into housing knowing that the government was trashing the dollar, and that they could pay their mortgages with increasingly worthless paper.

2. The American love affair for real estate has been propped up by a panoply of tax loopholes: mortgage interest deduction, deduction for HELOCs and equity loans, capital gains tax exclusion (raised from a once-in-a-lifetime $125,000 to $500,000 available every 5 years in 1997). Government partiality to homeownership apparently knows no bounds, as recent bailouts and planned future bailouts evidence. Eventually, the government will probably just have to step in and guarantee all troubled mortgages. The moral hazard of doing this will probably involve solvent debtors acting as insolvent in order to get the bailout: welfare for the affluent, if you will.

Here is a good article on the housing "crisis".

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As the article shows, there are really two crises: falling prices, and the excessive allocation of our national resources to, what the author terms, "personal castles". The end result is a decline in American business leadership, a monstrous trade deficit, and a trashing of the dollar to compensate.