As it’s clear COVID-19 will leave us with a financial crisis, more and more people are talking about a possible burst of a housing bubble. What does this even mean?
When people talk about a housing market crash, they can’t do so without mentioning a housing bubble. However, very few of them actually know what a housing bubble is and how is this occurrence connected with a market crash. As talks and concerns about the future of real estate are a hot topic right now, we have decided to further explain this term to you.
What Is a Housing Bubble?
A real estate bubble, also known as a housing bubble, is when rise in housing prices due to increased demand combines with speculation and excessive spending. This can result in a collapse. If we talk about steps of the process, a housing bubble begins with the increase in demand while the supply is very limited. This supply is usually so low that it takes too much time to replenish and increase it. Then, speculators pour money into the weak market, but this only drives up the demand further. It doesn’t take long before the demand suddenly decreases or even entirely stagnates, and at the same moment the supply increases. This results in sudden and sharp price drop. In other words, the bubble has burst.
Why Are Housing Bubbles Important
Even though a housing bubble is a short-lasting event, the factors leading up to it, as well as its consequences, can last for many years. It is usually caused when something is outside the norm – for example, speculation, high levels of investment, demand, or excess liquidity. All of this can make home prices unsustainable. All of this typically leads to a drop in supply versus increase in demand. This is similar to another occurrence, equity bubble. Still, housing bubbles are quite rarer, but they last almost twice as long.
Housing bubble will cause a major real estate market crash. This will, simultaneously, have a significant effect on everything, including neighborhoods, people of all classes, as well as overall economy. When it happens, people try to look for various means to pay off their mortgages, such as digging into retirement accounts. In fact, housing bubble is one of the main reasons why many people suddenly lose most or all of their savings.
What Is a Cause of a Housing Bubble?
While every financial market is prone to bubbles, they happen rarely in the real estate markets. This is because real estate is very illiquid due to large transactions and huge costs of home ownership. Still, it can appear. The cause of this is a rapid increase in supply, as well as in credits, combined with loosening of credit underwriting standards and low interest rates. This is sustainable, until suddenly credit standards tighten and interest rates rise, which leads to drop in demands. This change causes the housing bubble to burst.
2007-2008 Housing Bubble Burst
Everyone already knows about the great financial crisis that happened in 2007 and 2008. It was a result of a housing bubble that happened just a little bit prior to that. In fact, that bubble was, to an extend, a result of a bubble that occurred in the technology sector. Let’s explain a bit more.
In late 1990s, an expand in technology companies lead to increase of prices on their stocks bids, and this happened quite fast. Even little companies had a high value, no matter that they were yet to make actual profit. Speculators that attempted to earn big amount of money quickly bid them up to large market capitalizations. In 2000, it was the peak of Nasdaq, and the technology bubble burst. This made numerous formerly high-flying stocks to crash down, lowering price levels. This caused investors to abandon the stock market, which then lead to a stock market crash. Then, investors decided to move their money into real estate. At about the same time, the US Federal Reserve lowered interest rates and decided to keep them down, to improve the fairly mild economic recession that followed the burst of the bubble in the technological sphere. Another reason why they did so was because of the consequences of the 9/11 World Trade Center attack.
This sudden influx of credit and money combined with governmental policies that were encouraging homeownership, as well as financial market innovations, increased the liquidity of the housing market and its assets. Demand grew, and the housing prices increased. This reached alarming levels during the following six years. Interest rates plummeted while there were no more strict lending requirements. In fact, it was estimated that around 20% of mortgages that were approved between 2005 and 2006 were given to people who couldn’t afford them under today’s circumstances. All of them were clasified as subprime borrowers. Around ¾ of these subpreme loans were, in fact, adjustable-rate mortgages that were bound to reset after two or three years.
During that time frame, the stock market was healing, and around 2006 rates started to rise. As adjustable-rate mortgages were resetting at higher rates, economy slowed down. This also caused investors to stop investing in real estate. As the demand was no longer that big, home prices plummeted, resulting in massive mortgage defaults. This led to tens of millions of foreclosures in the next few years.
Will Housing Market Burst in 2021?
As of right now, there are no indications that the housing market will burst during 2021. While this is an unpredictable event, some of the warning signs aren’t there yet. While the demand for housing is a lot higher than the supply, this is moving at a slow pace and the trend isn’t likely to end soon or even rapidly. Also, there aren’t that many homes in forbearance program, so there won’t be enough mortgages to cause a crash. While 2021 will certainly bring us a financial crisis, it isn’t likely to bring us a housing bubble burst and, in result, a housing market crash.