Gambling with Housing: A New Research Paper Examines the History of Booms and Busts

April 11, 2013
by Doug Gavel

The great housing boom and bust in America during the first decade of the 21st Century was far different than those that preceded it. That’s one conclusion in a new research paper authored by Edward Glaeser, Fred and Eleanor Glimp Professor of Economics and director of the Taubman Center for State and Local Government, and the Rappaport Institute for Greater Boston at Harvard Kennedy School.

“A Nation Of Gamblers: Real Estate Speculation and American History” examines and compares several significant real estate bubbles over the past 200 years, providing a fresh perspective from which to parse out those factors which contributed most significantly to what he calls the “Great Housing Convulsion,” during which prices declined 36 percent from March 2006 to May 2009.

“Economists have now studied this Great Housing Convulsion extensively,” Glaeser writes, “but many questions remain unresolved. Why did spectacular booms and busts occur when and where they did? Were buyers largely rational, or were their beliefs inconsistent with any sensible model of housing prices? What role did Credit markets play in fueling the boom or causing the bust? What are the policy implications of the Great Convulsion?”

Glaeser’s analysis gleans several important findings. Among them:

• Boom-bust cycles can generate significant social costs, primarily through ensuing financial chaos, something that should motivate policymakers to examine those policies which impact housing markets;
• While low interest rates may have contributed to the housing boom, so did under-priced default options;
• The most dominant mistake made by investors was underestimating the potential impacts of changes in the housing supply upon prices.

“The ubiquitous nature of housing convulsions remind us that seemingly safe real estate investments can leave a gaping hole in bank balance sheets when things go sour. The tendency of markets to crash teaches that underpriced default options can lead to large social losses, especially because of financial meltdowns,” Glaeser concludes. “This fact implies that there may be advantages if bank regulators recognize the regular tendency of real estate values to mean revert after booms.”

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Professor Edward Glaeser

Professor Edward Glaeser

“Economists have now studied this Great Housing Convulsion extensively,” Glaeser writes, “but many questions remain unresolved. Why did spectacular booms and busts occur when and where they did? Were buyers largely rational, or were their beliefs inconsistent with any sensible model of housing prices? What role did Credit markets play in fueling the boom or causing the bust? What are the policy implications of the Great Convulsion?”