What’s a housing bubble?
Housing prices rise until they burst due to demand, speculation, and extravagant spending. The housing bubble begins with rising demand and limited supply, which takes refilling time. Speculators increase demand by investing in the market. The bubble bursts as demand drops and supply rises, causing prices to plummet.
Understanding a Housing Bubble
A housing bubble is transient but can last years. Manipulated demand, speculation, unusually high investment, excess liquidity, a deregulated real estate financing market, or extreme mortgage-based derivative products can cause home prices to become unsustainable. Demand versus supply rises.
The IMF says housing bubbles persist twice as long as equity bubbles while being less common.
Housing bubbles generate a prominent real estate crisis and affect all classes, neighborhoods, and the economy. They may require individuals to use programs or retirement plans to pay their mortgages and maintain their houses. Housing bubbles are a significant cause of savings losses.
What causes housing bubbles?
Housing bubbles are rarer than in other financial sectors due to high transaction and carrying costs. Rapid credit supply growth, resulting in cheap interest rates and relaxed underwriting rules, can stimulate demand and attract borrowers. High interest rates and stringent lending criteria can reduce demand, bursting the property bubble.
Mid-2000 US Housing Bubble
Technology bubbles contributed to the mid-2000s U.S. housing bubble. It is believed to have contributed to the 2007–2008 financial crisis.
In the late 1990s dot-com bubble, many new technology companies’ common stock rose to high values quickly. Speculators buy startups with little earnings and huge market capitalizations to profit quickly. The Nasdaq peaked in 2000, and many of these equities plummeted when the technology bubble broke.
Investors left the stock market after the dot-com bubble burst and crashed and bought real estate. The U.S. Federal Reserve lowered and maintained interest rates to counteract the slight recession that followed the technology collapse and to ease anxiety after the Sept. 11, 2001, World Trade Center assault.
With this flow of money and credit came government programs to encourage homeownership and financial market developments to boost real estate asset liquidity. More people bought and sold residences as prices soared.
As interest rates fell and lending conditions were relaxed, the homeownership craze reached frightening proportions during the next six years. About 20% of 2005 and 2006 mortgages went to people who didn’t qualify under regular lending standards. These were subprime borrowers. Over 75% of subprime loans were adjustable-rate mortgages with low beginning rates and a planned reset after 2-3 years.
Like the IT boom, the housing bubble began with fundamental price increases, but as the bull market progressed, many investors bought homes as speculative investments.
The government’s promotion of homeownership led banks to decrease rates and lending regulations, causing a house-buying boom that increased median home prices by 55% from 2000 to 2007. The homebuying craze attracted speculators who flipped properties for tens of thousands of dollars in two weeks.
The stock market rebounded, and interest rates rose in 2006. As the economy slowed in 2007, adjustable-rate mortgages reset higher. With high property prices, investors stopped buying properties due to the risk premium. Housing prices plummeted as house purchasers realized that home values may decrease, leading to a significant sell-off in mortgage-backed securities. From 2007 to 2009, housing values fell 19%, and substantial mortgage defaults caused millions of foreclosures in the following years.
Conclusion
- A housing bubble is a period of high prices and speculation in housing markets.
- Money flowing into property markets, permissive lending, and government policies encouraging homebuying generated a vast housing bubble in the 2000s.
- Like any bubble, a housing bubble can occur whenever market conditions allow.
