Explaining the housing bubble

The tremendous run-up in housing prices from 1997 to 2006, which ultimately led to the housing crash, has been blamed on many things: Lenders, rating agencies, insurers, government burocracy and cheap money providers have all had fingers pointed at them as causing the housing bubble. Do we know who is to blame? N.C. State University economist Mike Walden answers.

“Well …, we’re probably never, ever going to totally solve this or answer this question, but we have some new research from the prestigious National Bureau of Economic Research, and their answer … is everyone.

“What these researchers did is they did some surveys. They also looked at the actions of a wide range of players in the housing market. These are people involved in every phase of the housing market. And what they … concluded was that, really, the driving motivation for those involved in housing to push the housing bubble higher and higher and higher was simply that people psychologically began to believe in that housing bubble. They knew at some point it would come to an end, but they thought, ‘I can still make money before that bubble is burst.’ And so lenders, builders, investors, buyers continue to invest money in housing and push that level higher and higher and higher. Eventually it did burst.

“But I think the important thing here is that this has all the earmarks of what economists call a classic investment bubble. But really psychology takes over from economics – something we should keep in mind for the future.”

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