Housing bubble causes and economic consequences

Kindleberger's premise is that psychological mechanisms, rather than actual economic realities, are at the basis of market phenomena and crises. According to the author's model, there are several steps within the cycle towards economic crises. The six stages he identifies can be applied to the current housing market, which seems to be in the process of reaching the stage of crisis.

The housing market, more than many other economic factors, is very dependent upon environment-specific factors. These are flexible according to elements such as reputation and maintenance issues. The psychological factor then plays a particularly important role in the housing market. Generally, homeowners expect to sell at a substantial profit. This factor then makes home buying an attractive investment option. It is however also true that the apparent profit made by the home seller is not necessarily a realistic outlook in terms of investment. When elements such as maintenance costs over the years of ownership are considered, the profit is substantially cut in reality. Furthermore the profit made by the seller needs to be invested immediately in another house, further cutting most of or all profit to be made from the original investment. It is thus clear that the psychological factor creating a boom in a certain market has played a particularly large part in the housing market, as the boom began thirteen years ago.

While there are signs of exhaustion, there are still factors driving the psychological tendency towards home buying. One of these is the endogenous money supply fed by new credit instruments offered by banks. These include adjustable interest rates, which are offered at artificial teaser rates that expire some years after the loan is taken, no-money-down mortgages, and interest-only loans. These loan packages are offered to lure new homeowners who are often forced to sell as soon as the special terms of the loan expire. This then results in less than planned profit made from the initial investment, as is the case regardless of whether the house is owned for the duration of the loan. The result of loans to lure new homeowners is an overestimation of the return that can be expected from the initial investment. The boom created by this may indeed be the beginning of a downward cycle for the housing market. This boom is then the second point offered by Kindleberger. Increasingly insecure loans offered by banks feed the illusion that housing is a profitable investment, and thus results in overtrading.

Currently it is apparent that the housing market is at the fifth stage, where some insiders are leaving the market. While it is true that many still have faith in the housing investment, others have come to terms with the economic realities of the market, and made the decision to invest elsewhere. It must also be said, however, that the effect of Hurricane Quatrain may have substantial effects on interest rates. Falling interest rates cold then result in greater sales in the housing market.