Introduction to Housing Bubble Problem

House in the Bubble by Dharmesh Patel
House in the Bubble by Dharmesh Patel

In recent months, the term housing bubble has been noticed in several news articles, economic commentaries, and magazines. The question on everyone’s mind is whether the Canadian housing bubble is collapsing. But what does the term really mean? What could happen when it really bursts? And why don’t we prevent it? Let’s go over some housing bubble basics.

What is it?

A housing bubble or property bubble results in the rapid growth of real estate prices and mortgage credit. When demand for real estate increases significantly, it exceeds the supply. Supply becomes tight in the short term because it takes some time to build a new house. With exceeding demand, prices and rents climb up. The growth of both price and demand supports outstanding loans, and mortgage credit accelerates. Speculators enter the market, believing that profits can be made through short-term buying and selling. Then they drive demand up even more. At some point, demand stops growing and the supply increases, resulting in a sharp drop in prices — and the bubble bursts.

How to Identify and Prevent It?

There are a lot of discussions on this topic. Most economists claim that housing bubbles cannot be identified because they simply occur and cannot or should not be prevented. But others believe that a housing bubble can be identified though housing market indicators. The best known indicators are house price indices (HPIs), which measure the price of residential housing. HPIs for the United States are called Case–Shiller indices, and they showed quite accurately that the US experienced a housing bubble in the second quarter of 2006. Economists also often use home resale prices compared with personal incomes as another housing bubble indicator.

Another topic for discussion is how to prevent a housing bubble. Some economists argue that governments and central banks can and should take action to prevent bubbles; others say that they aren’t able to do so and that they can only clean up the mess after the bubble bursts.


Canada’s HPIs

Drifting Away by Steve Barringer
Drifting Away by Steve Barringer

The Canadian house price index is maintained by the Canadian Real Estate Association, based on sale prices averaged by region. In December 2008, the National Bank introduced a monthly house price index based on resale prices of individual, single-family houses in selected metropolitan areas and based on actual sale prices. The Bank also operates a forward market on Canada’s house prices. Statistics Canada monitors the New Housing Price Index (NHPI) based on monthly data. It measures changes over time in contractors’ selling prices of new residential houses.

When the Bubble Bursts

We can observe the consequences of a bubble bursting in the US. It has been well studied, documented and discussed in countless books, magazines, academic papers, and TV shows. The immediate effect is the depletion of wealth resulting in a negative impact on household consumption. A decrease in demand destabilizes the banking system, and investors are unable to pay off their debts. Many households that took out loans are unable to cover the debt. Unemployment increases. The bankruptcy of banks and other financial institutions may have a negative effect on the financial system and even on industry. In most cases, the government has to involve itself in the stabilization of the country’s markets with the unavoidable increase in public debt.

Interesting Links

About NHPI
10 Indicators of Housing Bubble Collapsing
Canada’s Housing Bubble

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