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Four Lies Believed During the Housing Bubble

Posted: 26-12-2008 | Views: 221

There are a number of fallacies about residential real estate that either affirm the belief in perpetually rising prices or minimize the fears of a price decline. These fallacies generally revolve around a perceived shortage of housing or a belief that the higher prices are justified by current or future economic conditions. These misperceptions are not the core mechanism of an asset price bubble, but they serve to affirm the core beliefs and perpetuate the price rally.

The main confirming fallacies witnessed during The Great Housing Bubble were:

* It is Different This Time
* Prices are Supported by Fundamentals
* Everyone Wants to Live Here
* They Aren't Making Any More Land

In every financial mania, people believe it is different than the last one. They will point to changes in economic conditions or some other factor and contrast current conditions to past ones. This contrast is taken as evidence that a previous crash will not be repeated. The only thing that is different in each financial bubble is the plethora of bogus reasons why it is different.

In every asset bubble people will claim the prices are supported by fundamentals even at the peak of the mania. When rental cashflow models fail, which they do during the rally of a housing bubble, the arguments justifying prices turn to an owner's ability to make payments. The argument is that everyone is rich, and everyone is making enough money to support current prices. Data proves this argument to be a fantasy.

Everyone believes they live in a very desirable location; after all, they choose to live there. People who make this argument fail to understand that the place they live was just as desirable before the bubble when prices were much lower, in fact, probably more so.

The fallacy of running-out-of-land plays on this temporary condition to convince market participants that the shortage is permanent. The idea that all land for residential development can be consumed ignores one obvious fact: people do not live on land, they live in houses, and land can always be redeveloped to increase the number of housing units.

All of these arguments are fallacies. Most of the buyers in The Great Housing Bubble believed one or more of them, and it was their faith in these fallacies that gave them the false sense of security that they would not lose money. They were sadly mistaken.

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