The cycle of bubble and bust in housing is drawing to a close. For many, the ferocity of the bust and the collateral damage that followed was a shock, but bubbles and busts are not new; chances are there will be more.
I got interested in bubbles in early 2008 trying to figure out why my model of real estate prices that had worked perfectly for ten years was saying that prices in Dubai which is where I was at the time, "should" have been 30% less than where they were.
This is what I found out:
Law #1: All bubbles need a catalyst, like a stone to throw into a still pond.
Bubbles start in "good times", typically GDP is going up and people have money to spend and invest, so money starts chasing assets and if it takes time for the supply of those assets to increase, prices go up.
For example, the fundamental price of housing long-term is exactly equal to nominal GDP per house divided by a function of long-term interest rates [1] . When nominal GDP goes up a lot faster than the supply of housing does, then the price of housing goes up; that's supply and demand, there is nothing wrong with that but it's the pebble in your hand; just you didn't throw it yet.
Law #2: Easy Money
Years ago I was friends with old man from Texas, he had a big silver buckle on his belt and crocodile-skin boots, and he used to eat three fried eggs, a slice of steak, for breakfast, extraordinary! Lovely guy; full of stories, he had a sidekick called Ron, and Ron wore "Blues Brothers" shades, and never said a word. I was just a kid and he was like in that Jerry Jeff Walker song..."Desperado Waiting For A Train" which he used to play on his car cassette-player over and over; it was that long ago. Anyway he'd been through the S&L and well, let's say, he was a long way from home.
One day I asked him "what happened"? He said "Son"...when he was being serious he always used to say that...
"Son when the money starts chasing the projects not the projects chasing the money, that's the time".
If credit is available at less than the asset price inflation, people who participate can make money from nothing,…
