No one disputes that housing prices in the United States since 1995 have soared way beyond inflation. However, that alone does not reveal a housing “bubble.” Escalating home prices could be caused by a shift in fundamental economic factors that leads people to value home ownership more than they did before, in relation to other goods and services. On the other hand, if home prices rise without regard to real value, then we have a bubble in the making. A bubble forms as rising prices lure more buyers into the market who are looking to build equity before prices rise further, regardless of the real value of the asset. This increases demand, prices rise even more, and the cycle continues.
Before the technology stocks (for example, “dot-coms”) crashed in 2000, many economists argued that such stocks were on the verge of cutting-edge technology that would revolutionize business. They were not overvalued, they said. There was no stock bubble, they insisted, in spite of outrageous price-to-earnings ratios compared to historical standards. But they were wrong. Since the dot-com bust, the technology stocks have not recovered and the stock market as a whole has been stagnant.
Likewise today, some argue that there is no housing bubble. How can we know if there is, and if so, what are the ramifications if it bursts—not only for the U.S. but for the many countries around the world that have experienced similar trends in housing in recent years?
A Merrill Lynch economist, David Rosenberg, identifies six characteristics of any kind of asset bubble: overheated prices, over-ownership, too much debt, speculation, complacency and denial. Let’s examine these factors in light of the U.S. housing market.
