Understanding Real Estate Bubbles

To better understand the current real estate bubble, we need to examine how the real estate market works, not only in the United States, but in other countries around the world. Since 2005, real estate bubbles have existed in the United States, and also in Great Britain, Australia, New Zealand, Ireland, South Africa, Israel, Greece, Russia, and China, to just name a few. In 2005, the Economist Magazine stated that “the world wide rise in house prices is the biggest bubble in history”.

A real estate bubble exists when property values increase rapidly and reach levels that are unsustainable, given the economic conditions that exist at the time. Unfortunately, the fact that a real estate bubble even exists is not identifiable until the market correction begins. Property values rise, and when the market begins dropping, the bubble “bursts”. Unlike a stock market crash following a bubble, a real estate crash and recovery is a slower process because it is not as liquid as the stock market.

The current housing condition in the US is thought to have begun in 2001, especially in California, Florida, and New York, and then spreading to the midwest and southwest markets.

The 2001-2002 recession gave way to better economic conditions as homeowners refinanced their loans to reduce their monthly payments or withdraw equity from the increased value of their homes. When the housing bubble burst and the value of the homes declined, many homeowners were now facing the fact that their home was mortgaged for more than it was worth. This, in turn, affects other properties in the immediate area, in that multiple foreclosures in a neighborhood cause a 10% to 20% decline in property values and wipe out whatever equity did exist before.

National home prices fell drastically in March, 2007, the worst drop since the savings and loan scandals in 1989. In August, 2007, a world wide credit crunch developed when it was discovered that many banks held sub-prime mortgage-backed securities in their portfolios. The Federal Reserve then injected $100 million into the money supply so that banks could borrow at a lower level.

At the Economic Symposium in September, 2007, critics blamed for Federal Reserve Chairman Allan Greenspan’s policy of low interest rates for part of the reason for the housing boom and the ultimate burst. Though it stimulated the economy at the time, the actual results of the rate cuts are now being felt in every part of the country and beyond.