Mauro F. Guillen
Director of the Lauder Institute at the Wharton School
Bubble Essential Part of Market Economy
Characteristically, they are based on assumptions that at some point turn out to be unrealistically optimistic or otherwise at odds with a supposedly ``hard'' reality.
When a bubble finally bursts, people always ask two questions. First, why did it last so long? And second, why are the effects so severe?
Obviously, the two are related to one another.
Of all bubbles, those involving real estate have the potential of lasting for a long time and having devastating effects.
The reasons are that people tend to be extraordinarily optimistic about real estate prices, they tend to participate in the creation of the bubble with borrowed money, and when the first signs of trouble appear, it is always easy for new buyers to wait and see, thanks to the existence of a relatively well-functioning rental market.
Much has been written recently about the existence of real estate bubbles in several European, Asian and North American markets.
Central banks, governments, international agencies, lenders and mere observers have pointed out that the combination of several years of hefty price increases and tighter credit conditions as of recent might bring about a self-reinforcing spiral of decline in real estate prices. While I do not wish to ignore the signs of trouble ahead, it is important to put things in perspective.
The market for real estate is a peculiar one.
People buy real estate because they need a place to live or to vacation. They also buy it as a store of value or, yes, to speculate.
Moreover, in some economies, the real estate sector has come to play a very important macroeconomic role.
Cheap credit guaranteed by real estate has made it possible for people to leverage themselves as investors or as consumers.