Housing "Bubble" is Suspect

April existing home sales in the US came out yesterday and set a record. Some 7.2 million existing homes were sold, that is their contracts actually closed, beating the previous record by around 180,000 dwellings. The nattering of pundits about a housing bubble in the US increased in volume but provided no more clarity. In part, this reflects a general economic ignorance among talking heads, but it also shows that people are worried about rising housing prices. That concern is a chief reason why one is suspicious of housing bubble speculation.

Speculative bubbles are an inherent part of markets. Economic theorists are the only ones who speak of rational markets – traders know differently. Markets operate on greed and fear, very emotional factors. When there is excessive exuberance in a market, prices soar, and the greed outstrips the fear. The trend is thought to go on forever, or at least until this one last trade can be liquidated. Tulips in Holland three centuries ago or dotcom stocks just a few years back are prime examples of this psychology.

If market forces are allowed to work, any bubble will eventually burst. Someone will realize that the money is flowing the wrong way, resulting in a misallocation of resources, and that will start a shift in behavior. George Soros, the man who broke the Bank of England just over a decade ago, played such a role in ousting the pound from the European Monetary System.

The real issue is how much worry there is over price increases (or declines). Experience shows that the time to worry is when one’s brother-in-law assures one that the price can’t possibly come down; the bandwagon is leaving and one must jump on or suffer. The readjustment that occurs when the bubble bursts under such circumstances is quick, painful and often overdone in the other direction. When there is some skepticism in the market, such that a noticeable minority is moving out of the market, the change will be less rapid and less harmful to the economy. The bubble deflates rather than pops.

That is where the housing market appears to be now. The usual cheerleaders are there, but the talk of a bubble is keeping some folks cautious. Compare that to the dotcom bubble – how many articles appeared warning of a collapse? With the median American home above $200,000 for the first time ever, it is likely that housing prices are too high given the current economic environment. But that doesn’t mean there’s a bubble that will destroy the economy when it explodes. It just might mean that people are sinking money into bricks and mortar because the stock market returns have been so poor in the last few years.



© Copyright 2005 by The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without written consent.
Produced using Fedora Linux.


Home