A Bubble Like Any Other?

The Case-Shiller Index shows that home prices nationally have fallen more than 33 percent since the housing market peak in 2006. The bursting of the market bubble resulted in billions upon billions of lost home equity. Enter the worst economic recession since the Great Depression, financial crisis, and subsequently weak economic and housing market recoveries. Unsurprisingly, people have and will continue to ask, “What caused it?”

A new paper by Boston Fed senior economists Christopher Foote and Paul Willen and Atlanta Fed economist Kristopher Geraldi takes a stab at answering this question. Or at least they attempt to shed light on market conditions before and after the burst.

They argue that borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices.

This does not remove deceptive mortgage brokers, adjustable rate mortgages, or injudicious homebuyers from the equation. But it means the housing bubble, characteristically, was a bubble like any other.

The paper debunks a number of myths associated with the bursting of the housing bubble and the narrative that formed to explain it. See WSJ’s abridged version of the paper’s 12 facts about the mortgage market during market boom here.

In the end, it may be bubble theory and the collective behavior of market participants that most adequately explain the lead-up to the financial crisis. While the Administration works on a host of new regulations to prevent the events of the last few years from repeating, they should be mindful of the underlying facts. And that a needed recovery in housing won’t come in an economy in which more people give up looking for work than those who find work.