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A house bubble is a continuous increase in the house prices due to increased demand for houses and speculation. The rise in the housing prices leads to speculation that the housing sector is profitable. This leads to more investments in the real sector b y individuals who run down their savings and purchase mortgages. Due to increased purchase of mortgages, the supply of houses increases more than the demand leading to a stagnated house prices and then a fall a scenario referred to as bubble bursting. The bursting of a bubble has various effects on the economy. It reduces the household consumption and private investment slowing down the economy. This paper discusses the U.S housing bubble and its effects on the U.S economy.
The Housing Bubble in the U.S
According to McKinnin & Stoeckel (2005), housing bubble is the run up in the house prices that is fueled by soaring demand, speculation and the belief that the latest history is an infallible forecast of the future. A real estate bubble usually begins with an increase in the demand (shift in demand curve of real estates) for real estates while the supply is limited for a relatively long period. Through speculations, there is a belief that profits can be realized in the real sector in the short-term period by buying and selling the houses (mortgages). Due to speculation and the belief of short-term profit, demand rises further. However, at some point, there is a stagnant or a decrease in the demand that is realized by the leftward shift in the demand curve. The low demand in the real house happens at the time that there is an increase in the supply of the houses resulting to a drop in the house prices. The decline in the house prices as the supply increase and demand decreases is what Michael, Jonathan & Damian (2008) calls the bursting of a bubble in the real estate.
According to Saxton (2008), the rise in the housing prices in the U.S since 2000 has been described as the biggest housing bubble in history. The boom in the housing market was driven by the low interest rates and a lack of perceived returns on stock markets that resulted after the bursting of the stock market bubble in 2000. Share slump, changing perceptions of relative returns on assets caused investors to switch holdings of assets in favor of housing. As investors switched preferences from stocks to property, rising prices of houses generated expectations of further rises in property values, fuelling additional speculative demands (McKinnin & Stoeckel, 2005).
Saxton (2008) argues that the housing bubble does not burst like a stock market bubble. At the end of a boom, the house prices stagnate and then begin to fall. The inventory of the unsold houses increase leading to a reduction in the house prices. After the bursting of the U.S, housing bubble house prices fell below 20%. The bursting of the housing bubble has several economic effects. According to Michael, Jonathan & Damian (2008), a burst in housing bubble usually results in les activity in the housing sector with more resources being availed for activity in other sectors of the economy. The major effect that affects the economy is the effect of the bursting of the bubble to the wealth of the household that affects consumption in turn (Saxton, 2008).
A rise in the house prices leaves homeowners richer with increased consumption. Additionally, more people run down their savings by taking more mortgages and increase their equity. However, after the bursting of the bubble, the households reduce their expenditures due to a fall in their investments in mortgages. Investors shift their focus to others sectors in the economy. Therefore, the bursting of the bubble affects the real activity in the economy. Other effects are a drop in consumer consumption and private investments.
This paper has reviewed the literature on the housing bubble experienced in the U.S. the housing bubble is characterized by an increase in the house prices resulting from high demand and low supply and speculation. The high prices lads to more profits and more investment in the real sector. as individuals tae up more land to finance their mortgages, the supply for houses increases while the demand decrease leading to stagnated or reducing house prices (bubble bursting). The bursting of the bubble has bad effects o the economy such as low private investment and household consumption.