The Real Estate Bubble
The real estate prices’ going up is going to lead to an increase in spending on the part of the normal consumer, as an increase in prices would create a feeling of increase in assets and thus promote consumerism.
The year 2005 saw the prices of houses going through the roof. This trend led to a serious question whether can the real estate prices bubble sustain or will it burst? The impact on the economy that this fall would bring was certainly a matter of grave concern.
The housing field has been the focus throughout the year 2005 as the prices were just rocketing and in some places the so-called “hot properties” were just unimaginable. The houses were getting unaffordable for the common man. The gap between the income of the person and the prices of the houses have been rising with absolutely no reason or explanation.
The housing prices and the affordability index were moving in opposite directions and the question of whether this artificial rise in prices of homes could be sustained or not became the talk of the town. Many experts in the field began getting concerned as to whether this was just a bubble and what would be the consequences if it bursts and the property prices come crashing down.
Impact on Business
Business would be affected in many ways with the real estate bubble bursting as this is going to have a direct impact on the economy of the country. The spending by the consumers accounts for about two thirds of the spending in the economy and with real estate prices going up the spending has also got a boost. With prices of houses going up the consumer feel a sense of increase in assets and thus, the resultant increase in their spending!
With a falling or stagnant price scenario setting in this would lead to directly reducing the spending by the consumers making a huge impact in the economy as a whole and its individual sectors as well.
The Asset Bubble
The asset bubble condition refers to a scenario that with high prices the investor feels that the trend is going to continue and the prices are going to get higher and higher.
The crashing NASDAQ stock market is an example of the asset bubble and it’s bursting in no time and for no particular reason at all. The boom in the NASDAQ for some time before it came crashing owed only to a tremendous rise in the prices of technology stock prices. Although there were some companies among the technology companies which had not shown any profitability yet the mad rush towards technology got people buying all technology stocks and so the artificial boom not backed by logical reasoning came to a sudden halt and fell sharply.
Along with the NASDAQ there were other markets like the Nikkei Index (of Japan), which saw a sharp decline. Although after the crash many studies brought out several reasons to explain the boom like low interest rates, overconfidence on the part of the average investor, aggressive steps of promotion by financial institutions and the like.
The asset bubble cannot be said to be a trend restricted to only the stock or the capital market. The episode of the Dutch tulips, which was observed in the 17th century, is yet another example explaining the asset bubble. The tulip prices went through the roof after it was patronised by the rich and famous in Europe and this led to more people investing in the tulip business to make a quick buck.
The whole of Europe was caught in the tulip with tulip transactions becoming the main business either directly or indirectly. With the supply increasing at this rate, the event that was most unexpected occurred. The tulip prices crashed (with speculation increasing and people beginning to liquidate their profits). This brought about the downfall of the tulips from which it never managed to recover till date.
The Trend In The US Market
The trend observed in the real estate scenario in the US seems to be a case of the asset bubble case going by some of the signs like a low interest rate, aggressive promotion on the part of financial institutions and the like.
The Us real estate scenario is a result of the recession that set in during the year 2001 as a result of which the Federal Reserve reduced the interest rates. With low mortgage rates the demand for houses saw a sharp rise and thus, the demand led to a rise in the property prices.
The financial institutions came into the scene and made it more affordable by making the initial payments to be made very low and within reach. There were mortgage offers, which were very attractive with no down payment required and terms like a 0% interest for the first year of starting. This made it affordable for more people and led to an increase in the demand for homes, which in turn led to the rise in the real estate prices.
The crash in the stock market in the year 2000 led to the returns of the stock market being not attractive at all. With the real estate field being very attractive, the chance to make a quick buck brought in a lot of investors to the real estate field. Many people who came into the real estate business came with an idea of buying the house and making a good profit with a resale.
If this trend goes on then the increase in the sale of houses or the supply would result in a sharp decline in home prices bringing down the real estate market.
The Real Estate Bubble
The existence of the asset bubble in the real estate business is shown by several facts to back it. There are points for and against the real estate market and the debate whether the bubble would burst or not continues.
The facts that point towards the real estate bubble bursting suggest that:
The borrowers have been put in a very vulnerable situation with the creative mortgage instruments available. The rising interest rates lead to an increase in the payments that have to be made on a monthly basis in an adjustable mortgage rate scheme. The creative mortgage instruments make many people fall prey to the attractive mortgage offers even though they may not be in a position to actually afford it leading to several cases of bankruptcies. There is evidence of an increase in the number of cases of bankruptcy.
The creative mortgage instrument has led many people to enter the mortgage scenario and thus the boom in the housing sector. It is shown that a large portion of the population is opting for these creative mortgage instruments and thus, in any case of increase in the payments and there being no proportionate increase in the incomes of these people then a situation of increased bankruptcies, defaults in payments would be a common feature.
Real estate or the housing sector has been a major employment-generating field in the US since the year 2001. There has been a trend of increase in jobs related to construction, real estate brokers and also mortgage lending. A spill over effect has been seen and directly or indirectly the housing sector has been among the largest sectors absorbing people. In case of a sudden crash in this field there would be number of jobs that would be affected. This would have a serious effect on the economy as a whole and with many jobs coming to an end the number of defaulters would increase.
The Government of the United States runs a deficit budget that has to be financed. The interest rate could be maintained and hiked to a certain level due to the consistent foreign demand. In case of a decrease in the foreign demand, this would result in an increase in interest rates to a very high level so as to attract more funds. The situation of a higher rate of interest would lead to more defaulters and even bankruptcies.
The world has witnessed a sharp rise in the value of residential properties in the developed countries over a period of the last five years. Some markets are however showing negative signs and are slowing down especially in Britain and countries such as Australia, New Zealand are also showing trends of slowing down. The slowing down of the housing market would have an adverse impact on the entire economy. The slow pace of the US economy would result in defaults and bankruptcies.
There are several factors that show that there is no bubble at all in the housing sector and there is thus, no need to be scared of a crash. The following are the factors that show that there is no crash at all:
The trend that is observed is that although there is vacant land in many places in the US, but people do not want to live just about anywhere they want to be in the happening places in the city where life is very truly “hot”. This demand for land in the prime locations within the city would ensure that the prices of houses are kept high and the boom is going to go on. The limited supply of land would result in high prices kept intact in the busy prime locations of the country.
The housing sector is an attractive sector for investments and thus, the trend of investing in vacation homes and several people are also thinking of second homes. There is growing foreign ownership also that is on the rise in the country. The investment opportunity that people see in homes would ensure that the home prices are kept intact in fact rising. Therefore, there is absolutely no chance of a downward trend in the housing sector.
The concerned authorities are always on the lookout for measures to control inflation. With inflation under control, there would not be a drastic increase in the interest rates and as per evidence it has been seen that the buying in the housing sector will not decrease significantly unless the interest rates go up beyond 8%. Thus, the boom in the housing sector is going to continue at the same pace without any interruptions.