What's really to blame for the housing bubble
Amidst all the arguing over the future of the housing market, you would be excused for thinking that the past -- specifically, what caused the bubble -- is crystal clear.
Au contraire, several economists say.
Way low interest rates, down payments and lending requirements? Those can only explain part of the price run-up, according to a new policy brief by Edward Glaeser, Joshua Gottlieb and Joseph Gyourko, the former two of Harvard and the latter with the University of Pennsylvania.
They argue that interest rates alone probably account for just a 10 percent increase in price between 2000 and 2006, a small portion of the value escalation in many metro areas.
Theoretical and empirical analyses suggest that neither interest rates, nor downpayment requirements, nor approval rates moved enough over the past decade to generate the magnitude of price changes that parts of the United States experienced. Moreover, other standard explanations for rising housing prices, like rising incomes, also fail to explain much of the price volatility. Using the standard toolkit of the empirical economist, we are unable to offer much of an explanation for what happened.
Perhaps UFOs were involved somehow. Or pixies.
Or, wait, perhaps it was good ol' human nature:
"We do believe that faulty expectations played some role in what happened," the authors write.
They note that standard economic theory expects buyers to rationally assume that what goes up rapidly won't continue on in that way forever, and in fact will probably come down. But many Americans, buyers and homeowners alike, didn't see things that way in the booming middle of the last decade.
"If economists are going to better understand housing bubbles, we will surely need to accept that home buyers often have very exuberant beliefs about housing prices," the authors conclude in "Did Credit Market Policies Cause the Housing Bubble?"
Blogger James at the Bubble Meter says it's a two-to-tango situation, in his opinion:
I have long believed that fundamental factors spark all bubbles, but then a get rich-quick-mentality takes over in the minds of buyers as they watch asset prices rise. As they buy up assets in a quest to chase the market, this increased demand pushes prices up even more, which then convinces more people that they can get rich quick by jumping in. Thus a feedback loop develops where the get-rich-quick mentality becomes a self-fulfilling prophecy, until something finally breaks the cycle. Then the cycle reverses itself.
One of the interesting things about housing is that -- unlike, say, tulips or dot-com stocks -- everyone needs it. (You don't necessarily need to own it yourself, of course, but stay with me here.) From talking to buyers in those crazy days, I know that desperation ("If I don't buy now, I'm never going to be able to afford a house!") was a definite factor. But then, "If I buy now, I'll double my value in a year!" played a role, too.
How much of the price run-up do you think was purely the fault of buyers and refinancing homeowners?