Understanding Real Estate Bubbles

A real estate bubble is not unlike any other type of bubble namely a stock market bubble. The idea of a bubble is that what it is constructed on his unstable and ready to fall apart at any moment. To understand the real estate bubble allow us to analyze what happens in a stock market bubble.

In the stock market when more people buy than sell, OR as to say when more dollars are used to buy than dollars are desired from selling, the stock market increases in value. Inversely, when more people desire dollars now than the promise of more dollars in the future OR when more dollars are sought now than more dollars in the future, the stock market goes down. A bubble is created when there is some sort of false observation that things are going to be great for a long time to come, and commonly this bubble is driven up by excessive optimism which blinds people’s good judgment. For example a young investor who is usually prudent, but is caught up in the prospect that if he stays in just a little longer and the market increases a little more he’ll reach most of his financial goals. In other words, he acts foolishly optimistic. Or if people feel that the current employment situation, the current business revenue growth will continue and good times are likely, they will keep their money in the market and continually increase the amount that they are willing invest it it.

This hope that times will continually be good attracts more and more people. Another aspect is the way that money is obtained to place money in the market. People may take money out on credit cards that advertise low interest rates and use the money in the stock market. These competitive day traders are one of the main major causes of a crash. A market that operates on a typical sense of reasonable investing will experience an upward thrust if money taken out on credit is placed into it, because typically credit card money is used in storefronts and drives up the profit margins of the companies themselves that there stock market prices. There are two ways then that one could, if in an all powerful position, drive up his own stock price. Will his customers to spend more for each item: more profit, higher stock price. OR. Convince his customers to use their credit cards to obtain cash to purchase more of his stock: more stock purchases, attracts other investors, drives up the stock price. Using credit cards to buy credit is almost always a bad idea, and artificially inflates the stock market.

But what motivates people to act in this manner? A long time without a crash, and jealousy. As the US gets better at knowing what the economy is going to do, the longer the economy and the stock market goes without a crash. The common person observing these feels safer with each passing year. Each year assures them that the stock market is safe, rather than convince them, that the farther we get from our last recession the closer we are getting to our next one. In addition people become jealous of other investor that experienced maybe five years of solid growth. Thus, they feel that they should get in now and maybe they’ll experience at least three or four good years of growth.
It is when all feel that the market is too good, when it won’t turn bad, when using credit sounds like a good idea, when it can never go bad, that people become blindly optimistic and place too much in the market.

At this exact moment those that have been in for five years or so and enjoyed long profits finally realize that their friends and family are over investing and thinking too optimistically that these long term investors decide to finally take their money out and enjoy their profit. Once a few of the big investors pull out, the next rung of investors take this as a clue, and they pull their money out. Money coming out of the market drives the market prices down. Now even more feel that it is a good time to get out and suddenly many more are selling than buying. Thus, the bubble bursts.

Now onto the real estate side. The same blind optimism happened in the real estate bubble. Loan officers, mortgage bankers, and real estate investment corporations felt that the prices of homes would continually increase and go upward for a much longer time.

Loan officers were writing bad loan aps, mortgage bankers were approving them. And real estate investment corporations were ignoring the idea that soon it would all end. Continually putting more money in the market after realizing that it has grown for too long creates a bubble. Soon the big investors start selling their homes, home prices start to fall, less people take out big loans, thus loan interest rates start to increase, which places pressure on those trying to pay their mortgages, and people start to default on their mortgages. A few defaults sends a message to even more home investors that the ability for people to get loans may be difficult. Ultimately, people realize that the good times are over and start selling instead of keeping their home off market until prices are better. But they find that they can’t sell the house at the rate they thought. They have to lower their house prices, and the prices across the market begin to fall.

Bubbles are created by people ignoring common economic indicators and relying upon a sensation of endless hope and continual growth. Bubbles are inflated by blind optimism.