A bubble in the American housing market – fueled in part by so-called “sub-prime” mortgages – was the catalyst for today’s financial market turbulence. But the bubble was not confined to the United States. In Europe, house prices have also increased sharply over the last decade – more dramatically than in the US in many cases. The same is true of other OECD countries and emerging markets, where rapidly increasing incomes have put pressure on asset prices.
Indeed, with a few exceptions (essentially Germany and Japan), housing prices have risen almost everywhere to levels never seen before. How could such a global pattern emerge when real estate is the most local of all assets?
Recent research suggests that the global housing boom was closely linked to the unprecedented increase in the supply of liquidity by major central banks. To be sure, financial innovation, like lending to buyers who would not normally have qualified for mortgage loans (sub-prime borrowers) also played a role. But sub-prime mortgages would probably not have been supplied on the same scale if central banks had not created an environment of ample liquidity and persistently low interest rates.
The sub-prime crisis has so far affected mainly financial markets in the US and Europe. This is not surprising if one considers that on both sides of the Atlantic prices have reached historical peaks and, until recently, had accelerated.