Throughout the housing collapse of 2007 there was a term used over and over again: The Housing Bubble. The imagery is easy to understand- a market grows to a certain point until it pops. With the phrase used so often, I thought it would be good to discuss what exactly a bubble is; what causes a housing bubble; and, are we currently in one?
What Is A Bubble?
Limited supply causes prices of houses to increase above their normal average. Going into 2007 certain housing markets were seeing double digit increases. Economists consider a strong housing market to have price increases of 5% yearly.
Due to the lengthy time to build a home, as well as limited land in many cities, buyers were having to outbid each other. The resulting bidding wars creating a “rising tide” for all house values. Many owners took out loans on their homes assuming that the prices would keep increasing at a double digit rate. 2008 proved that in fact those prices were not sustainable. The resulting bursting of the bubble left many owners owing more for homes than they were worth.
What Causes A Bubble?
Many factors contributed to housing bubble of the early 2000’s. While none were the main culprit, the combined effect was crippling to the world economy. Here’s a couple of reasons:
- Upturn in the general economy gives more disposable income to spend on housing.
- Low interest rates. Especially low introductory rates.
- Innovative mortgage products with low monthly payments to make housing more affordable.
- Easy access to credit (a lowering of lending standards). Speculative and risky behavior by institutional and real estate investors.
What Causes A Bubble To Burst?
An increase of housing supply while demand is decreasing resulting in a lower prices. Quite simply: Buyers weren’t willing to pay as much for the houses that were on the market. Additionally, many owners borrowed more than their home was now worth. Which led to an increase in foreclosures. The resulting flood of foreclosures only pushed prices lower, as buyers were purchasing them at a steep discount. Other factors included:
- Increase of variable interest rates. Making home-ownership harder and increasing monthly payments for current owners.
- Downturn in general economic activity making people spend less on housing.
Are We Currently In A Housing Bubble?
When asked about the chance of being in a housing bubble in a recent Fortune Magazine article, Warren Buffet responded, “I don’t see a nationwide bubble in real estate right now at all.”
He continued to say that housing isn’t as attractive as it was in 2012, but is still a good time to buy a house. House prices have climbed back to their 2008 levels, concerning some economists.
That said, the increase in value has been a slow and steady climb that has mirrored the economy at large. Much of the increase in economic activity in the run-up to 2007 was from the housing boom.