Many people did not see the NASDAQ tech-stock bubble. Many people did not see the great housing bubble either. Those who participated in either financial mania lost a great deal of money. People need to know what to look for in order to avoid future financial manias.
A financial bubble is a temporary situation where asset prices become elevated beyond any realistic fundamental valuations because the general public believes current pricing is justified by probable future price increases. If this belief is widespread enough to cause significant numbers of people to purchase the asset at inflated prices, then prices will continue to rise. This will convince even more people that prices will continue to rise. This facilitates even more buying. Once initiated, this reaction is self-sustaining, and the phenomenon is entirely psychological.
When the pool of buyers is exhausted and the volume of buying declines, prices stop rising; the belief in future price increases diminishes. When the remaining potential buyers no longer believe in future price increases, the primary motivating factor to purchase is eliminated; prices fall.
The temporary rise and fall of asset prices is the defining characteristic of a bubble.
The bubble mentality is summed up in three typical beliefs:
* The expectation of future price increases.
* The belief that prices cannot fall.
* The worry that failure to buy now will result in permanent inability to obtain the asset.
The most recent asset bubble in the United States was in residential real estate. The housing bubble was characterized by the acceptance of the above fallacious beliefs by the general public, and the exploitation of these beliefs by the entire real estate industrial complex, particularly the sales mechanism of the National Association of Realtors.
The mantra of the National Association of Realtors is “real estate only goes up.” This economic fallacy fosters the belief in future price increases and the limited risk of buying real estate. In 2006, prices in many markets began to fall. By 2008, the rate of price decline had greatly accelerated. This is dramatic proof that real estate does not always go up. Despite this obvious fact, the National Association of Realtors still tries to lure greedy buyers with fantasies of unlimited wealth in residential real estate.
Buyers are already prone to believe the fallacies of unlimited riches in real estate, and these fallacious beliefs lead to housing bubbles. Realtors should be prevented from making representations concerning the investment potential of real estate. Since the regulatory framework for this kind of regulation and oversight is already in place under the auspices of the Securities and Exchange Commission, Congress would merely need to make Realtors subject to these regulations in order to solve the problem.
It is imperative to identify asset bubbles because people that invest in them almost always lose money; sometimes, they lose a great deal of it.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
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