Like a balloon
What, exactly, is a housing bubble?
It's a rapid increase in home prices that is followed
by a steep decline. By that imprecise definition, housing
bubbles are uncommon. Most booms end when home prices
plateau for a few years. Those aren't bubbles. A minority
of booms -- one-fifth, according to an FDIC study --
are followed within five years by busts. Those are bubbles.
Are you living in a housing bubble? You
can't know for sure until it bursts. A bubble could
pop, throwing home values down a flight of steep stairs.
But it's more likely that prices eventually will stagnate
for years while rents and wages catch up.
By the way, the aforementioned research
paper by the Federal Deposit Insurance Corp.? It
defined a bubble as a 30-percent rise in home prices
in three years, adjusting for inflation, followed by
a 15-percent drop in home prices in five years. The
researchers counted 54 booms in 46 metro areas from
1978 to 1998, followed by nine busts that began within
five years. The researchers spotted nine more booms
that began after 1998, but none of those markets had
popped as of the end of 2003, the latest data the scholars
had. Since they haven't had time to pop, it's too early
to know if those markets were bubbles.
Economists, builders, real estate agents and others
have attributed the steep rise in home prices to an
array of factors, depending on the market.
Builders point the finger at laws that impose restrictions
on land use and building density, and they complain
that protecting endangered species puts prime home-building
sites out of bounds. Recently the National Association
of Home Builders encouraged the federal government to
take the bald eagle off the endangered
species list to "help landowners and others
understand how to protect the bald eagle while continuing
to keep housing affordable."
In other places, the bald eagle isn't the designated
culprit, geography is. When prices were zooming in San
Diego, real estate professionals pointed out that the
city is bounded on the west by the Pacific Ocean, on
the south by Mexico, on the north by military installations,
and on the east by desert mountains. There aren't many
places to expand.
Immigration is a widely cited factor in California,
especially the southern part of the state. In South
Florida, experts blame rampant speculation, as short-term
investors buy condominium units and even houses long
before they're built, on the assumption that they'll
be worth a lot more after completion.
Speculation also seems to be the culprit in other markets
that have boomed in the last few years -- Phoenix, Las
Vegas, Boston, and New York City and Long Island, most
In their heads
The roots of housing bubbles grow in people's brains.
When you bid up the price of something because you're
sure the next buyer will pay even more, you have enlisted
into bubble psychology. If most of the local market's
home buyers join the ranks, prices spiral upward. Then,
at some point, prices slow down or stop rising or even
fall. In the latter case, a bubble pops. Sometimes there's
an external factor -- a recession or a big layoff --
and other times there's no discernible reason other
than people stop believing that prices will continue
to skyrocket, just as they stopped believing in the
tooth fairy when they were kids.