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Bubble, bubble

Back during the late-90's stock market boom, I read Robert Shiller's book Irrational Exuberance, which showed how share prices had become insane and a crash was around the corner. It didn't take a genius to see this, but Shiller's book was still worth reading because besides just making a strong economic case, he also discussed the psychological factors that made it happen.

His latest book is Irrational Exuberance: Second Edition, in which he uses the same techniques to look at the housing market. I haven't read it, because the graph showing the economic argument is about all I need to know:

Larger version. From Nouriel Roubini's blog, which has much, much more info.

I would qualify Shiller's graph by noting that there is probably a 'quality' factor in the rise in price of homes. People at least 'feel' richer, and have been buying bigger and bigger homes over the years (which are more valuable). But that in no way accounts for the doubling of prices in less than ten years.

Housing prices in the US have hit their zenith and have nowhere to go but down. In fact, even though the last batch of housing numbers in the US showed a miniscule increase in housing prices year-over-year, prices may actually be falling.Many economists and commentators have begun to point out that housing prices are inflated to an unknown degree by seller concessions: rebates on closing costs, swimming pools, new kitchen countertops, luxury trips once a year for life and other goodies detailed in a recent New York Times article. These and other expensive sweeteners are now par for the course as desperate sellers try anything to move their houses.

There are plenty of reasons this occurs. First and foremost is that the homebuilding and home-selling industry depends on the perception that housing is a no-lose investment in order to continue hawking its wares. Agents, of course, get paid based on selling price, so you can be darn sure they'd rather see under-the-table concessions than straight price drops.When it becomes common knowledge that prices are falling, buying will slow down even further as more potential buyers decide to 'wait until things settle'. Then the economy-wide pain starts.

The bursting of the bubble has started to happen in Canada too. Anecdotally, I've seen plenty of properties in my area offering 'reduced prices' on homes. But we're still mostly in the 'denial' phase. The next few years are going to be rough.


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