housing bubble

DEFINITION: A “housing bubble,” also known as a “real estate bubble,” occurs when the housing stock of a region or country undergoes a rapid and ultimately unsustainable increase in prices.

Housing bubbles are one form of a more general phenomenon: asset price bubbles. They are price bubbles in a market in which the asset being traded is housing stock and real estate. Like other kinds of asset price bubbles, housing bubbles may occur for a variety of reasons.

Bubbles in the housing market often begin with a surge in demand. The supply of housing stock, by its very nature, cannot be increased very quickly to meet this increased demand; hence, prices will inevitably rise.

If the housing market were functioning properly, this would not be a problem. The rise in prices would stimulate investment in the construction of new housing, and as new homes are built, over time prices would fall back towards the preexisting level, without collapsing through the floor.

Housing bubbles, then, are due primarily to forces that distort this normal functioning of the market.

ETYMOLOGY: The use of the term “bubble” in the economic sense is first attested from the early eighteenth century, more specifically in connection with the British South Sea Bubble of 1720. It is uncertain when the concept was first applied to the real estate market.

The English abstract noun “housing” is attested from the fourteenth century. It derives, of course, from the concrete noun “house,” which in turn derives from Middle English hous and Old English hūs, both meaning “house.” The Old English form is identical to the same word in Old High German.

The English noun “bubble” is attested from the fourteenth century. It derives from Middle English bobel.

USAGE: Housing bubbles may arise for many reasons, but generally speaking they occur mainly due to either government interference in the operation of the free market or else the “irrational exuberance” (in the famous words of longtime Federal Reserve Chairman Alan Greenspan) of investors, who get caught up in the outsized and apparently never-ending profits to be made by speculating in the housing market.

Real estate speculators may even be well aware that they are involved in a potentially dangerous bubble. But it appears to be a feature of human nature to believe that we ourselves can safely navigate the risks we know lead other people to ruin.

And, besides, the thought of getting out while the getting is good, which means forgoing an unknowable quantity of easy profits, is unendurable for many speculators. Leaving easy money on the table appears to require a nearly inhuman degree of self-discipline.

Sooner or later, though, the bubble must burst. And by the time prices start to crash, it may be too late to unload one’s holdings, leading to financial catastrophe.

 The other major factor which often helps to generate housing bubbles is government interference in the marketplace.

For example, the US government contributed to the 2008 real estate crash and subsequent cascading financial crisis by pressuring the management of the public-private mortgage lenders, Fannie Mae and Freddie Mac, as well as purely private lenders, to drastically loosen the criteria for qualifying for a home mortgage.

This policy not only fueled a massive spending spree, driving up home prices, it also led to a tsunami of defaults on those easy-to-get loans by individuals who lacked the financial wherewithal to service the debt they had taken on.

Defaults on home mortgages were followed in short order by waves of foreclosures.

Moreover, these foreclosures left many banks and other lending institutions—including some of the largest and most prestigious in the country—holding large numbers of worthless loans on their books.

This was so, in part, because the properties that the banks acquired through foreclosure were themselves worthless, since the real estate market had collapsed.

All of this led to a second tsunami of bank failures and, ultimately, to the politically unpopular expedient of government “bailouts” of companies deemed “too big to fail.”

The social consequences of a housing bubble may be far-reaching, affecting individuals belonging to diverse socioeconomic classes, reaching across many different regions, cities, and neighborhoods, and undermining the broader economy of a society.

Housing bubbles can compel people to explore various means of meeting their monthly mortgage payments or of paying off their mortgages entirely. Unfortunately, many end up dipping into their retirement accounts or other savings to stay afloat financially.

As a result, housing bubbles have been a major factor behind the significant decrease in the amount of money set aside in savings by the average American household over the past several decades.

With the passage of time, this trend will end up causing significant financial hardships for many. For this reason, if for no other, housing bubbles ought to be a topic of general concern.