The efficient market hypothesis – the notion that markets always reflect an equilibrium was proven incorrect in real estate markets during the bubble. Real estate prices traditionally were a reflection of the local economy. If the economy was strong, prices would generally rise until more homes were built. Then, they would level off as supply would match the demand. Declining prices, people used to think, were very rare because if supply rose too fast, then building would simply stop and developers would go out of business. Another popular delusion was that if someone paid too much for a home, it would never get passed the appraisal process, thus resulting in not being able to qualify for a loan. The deal would simply fall through or be re-negotiated.
Extended periods involving climbing price trends tend to be emotionally reinforcing. Folks believed that property or home prices perpetually increased which in turn triggered the real estate bubble arriving at an excessive level. The more prevalent the bias, the more the speculative funds in which the prevailing bias allures.
Crowd psychology is often incredibly vital concerning what inevitably occurs inside a housing market. George Soros believes that financial markets are invariably biased in one way or another and people’s perception may effect the actual occurrences they expect. This generally results in a short sighted impression that investing arenas are generally accurate. The fact remains, the marketplace merely will become less stable. This was proven the case by the large sum of individuals who got home loans with payments larger than they should have been able to qualify for.
What does this have to do with government regulations? A lot. First, governments will do almost anything to protect the existing system during the boom period of the cycle. Lax lending standards are a normal indicator of an overpriced market. In addition to this, investment banks were allowed to be heavily leveraged. Leveraging can lead to greater financial gain, but the reverse is also true on the downside. When leveraged at 40 to 1, a fairly small drop in face value is all it takes for an investment to get to zero.
At the top of the housing bubble, the talking heads had been swift to publicize the achievements of record levels of ownership. In reality, the situation was such that lots of individuals bought properties which they could not manage to pay for. The real estate mania also brought about a great sense of financial security, creating an undesirable personal savings rate. Folks believed they were financially safeguarded as a consequence of the substantial total of equity they were building in their properties. The fundamentals failed to influence the bias, yet the bias influenced the fundamentals. A false feeling of stability ended up being the most crucial trigger that eroded the structure of the housing market.
The results of the economic downturn in 2001 caused the Fed to bring about unnaturally reduced interest rates with the purpose of strengthening the economic climate. Financing money under the rate of inflation contributes to negative real rates of interest. Financing funds, particularly with low financing requirements and low interest doesn’t make items less expensive. In fact, cheap financing will cause selling prices to increase. Low interest rates will influence selling prices.. It’s a big misunderstanding that cheap borrowing costs are generally a positive thing.
Eileen Jacobs is a loan originator in Las Vegas, NV. She has over 30 years of experience in fields related to finance The Mortgages PhD Blog offers more insight on the housing bubble.
categories: housing bubble,government’s role housing crisis,george soros,efficient market hypothesis
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