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Housing Market Speculation Was a Disaster

Published by Lawrence Roberts | December 26th 2008 | Views:

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Many people decided to speculate in residential real estate markets during the Great Housing Bubble. Most were amateurs that had no idea what they were buying or why prices were increasing. The only thing they did know is that prices were going up, and they believed they would continue to do so forever.

The motivations for purchasing real estate or any asset differ considerably between investors and speculators. Since speculators rely on capturing the change in asset price, they are much more emotionally involved with the gyrations of market resale value, and since their emotions work against them, they most often sell at a loss. Trading houses became epidemic in the Great Housing Bubble. Houses became commodities to buy and sell and lost their intrinsic value as a shelter or a place to call "home." People utilized 100% financing and treated mortgage obligations as little more than options contracts.

The emotional cycle of an asset price bubble emanates from the emotional cycle of individual speculators. Efficient markets theory would say these emotions are irrelevant as each investor acts rationally based on fundamental market data. Behavioral finance theory argues our herd instincts coupled with irrational beliefs and expectations are primary forces at work in financial markets. Efficient markets theory fails to explain asset price bubbles, whereas behavioral finance theory does. When the bubble bursts, each speculator must go down around all those who subscribe to the cultural pathology. The activity of governments can serve to reinforce pathological behaviors, and when called upon by a desperate public, the government can pander to the emotional needs of the citizenry through generating false hopes and supporting denial.

Many people like it when houses go up in price. During a rally the bulls become intoxicated with greed and obsessed with owning real estate as an investment. However, once houses become an investment, the prices of houses begin to behave like an investment, and volatility is introduced into the system. When houses trade with the volatility of a commodities market, it causes more harm than good. Price volatility is a very disruptive feature in a housing market: the upswings are euphoric, and the downswings are devastating, and there are downswings. Declining house prices are emotionally and financially draining both to individuals and to the economy as a whole. The upswings create massive amounts of unsustainable borrowing and spending, and the downswings create economic contraction, foreclosures and personal bankruptcy. Is the ecstasy of a rally worth the despair of a crash?

Houses should not be viewed as a commodity to trade. Most people lack the financial sophistication to successfully trade in commodity markets. Buying and hoping prices go up is not a successful strategy. Volatility in housing prices is harmful to the community as the financial and emotional costs of the inevitable price crash are just too great. Everyone pays a price. Renters who chose not to participate are forced to wait to obtain the security of home ownership at an affordable price, and buyers who endure the crash... well, their pain is obvious.
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