Was the U.S. housing bubble caused by Speculation?

United States house prices increased by 8.9% per year nominally between 2000 and 2005. Economists began to believe that there had been a speculative bubble in the U.S. housing market. Investors speculated in the housing market, believing that house prices would continue to rise indefinitely. As a result, there was an increase in housing demand, which in turn caused home prices to rise.

When supply prices increased in real terms between 2000-2005, construction costs increased at over twice the rate of inflation. Consumers were typically expected to purchase less, but with the aggregate demand for owner-occupied housing also increasing, consumers purchased more owner-occupied housing. Three main causes for this:

1. An increased rate of homeownership, from 66.8% to 69%.
2. Household decisions to include more housing in their portfolios increasing from 23.8% to 30%.
3. Speculation in continued real house price appreciation.

                                                                   Figure 1.1 The bubble triangle

Source: Boom and Bust

However, we must also consider how marketability, money/credit, and other governmental regulations may have prompted price increases and fuelled the bubble.

•     More consumers than ever before had access to mortgage financing, which enhanced the marketability of homes.

•     There was a significant expansion of credit. By relaxing lending standards and reducing interest rates from 6.50% to a historically low 1.0% during 2001-2004, the Federal reserve allowed a growth in mortgage credit to high-risk borrowers on low incomes and a loan-to-value ratio of 100%.

Source: Federal Reserve Interest Rates

Many speculators found themselves unable to sell their homes for the prices they had hoped for when the housing market started to decline in 2006, and prices started to drop. This caused a surge in foreclosures, which in turn fuelled the 2008 financial crisis.

Source: Change in U.S. Housing prices