Bubble Trouble

The decline in US home prices closely resembles a bank run, which occurs when people, worried that their deposits will not be honored, hastily withdraw their money, thereby creating the very bankruptcy that they feared. When home prices stop rising, recent homebuyers may lose the enthusiasm to continue paying their mortgages – and investors lose faith in mortgage-backed securities.

The future of the housing boom, and the possible financial repercussions of a substantial price decline in coming years, is a matter of mounting concern among governments around the world. I learned this first-hand while attending this year’s Jackson Hole Symposium in the remote wilderness of Wyoming, where, ironically, there are almost no homes to buy. The howls of coyotes and bugling of elk rang out at night. But, by day, everyone was talking about real estate.

This conference has grown to be a major international event for government monetary policymakers, with governors or deputy governors of 34 central banks attending this year. Roughly two-thirds of these countries have had dramatic housing booms since 2000, most of which appear to be continuing, at least for the time being. But there was no consensus on the longer-run outlook for home prices.

Of all these countries, the United States appears to be the most likely to have reached the end of the cycle. According to the Standard & Poor’s/Case-Shiller US National Home Price Index, US home prices increased 86% in real, inflation-corrected, terms from 1996 to 2006, but have since fallen 6.5% – and the rate of decrease has been accelerating.

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