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Irrational Exuberance

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  • May 22, 2013
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Irrational Exuberance and the Housing Bubble

An investment in real estate is widely regarded as one of the best investments one can make. The notion that home prices will always rise is as strong as it is incorrect and in the early 2000’s this line of speculative thought led to a level of irrational exuberance that threatened to topple the U.S. economy and its financial system.

After the dot.com bubble burst and the subsequent 70% drop in the NASDAQ, investors both professional and amateur clamored for a safe harbor for their investments. Real estate had a long standing perception of being a relatively risk free investment and appeared to be a suitable alternative. With the new influx of investment dollars hitting the real estate market the prices of homes soon began to increase. Also as a result of the dot.com crash the Fed began cutting its short term interest rate from 6.5% down to 1% in an attempt to overcome the 2000-2001 recession. With easy access to cheap money, rising home values and reliable public information being made widely available by our media outlets, the American public would soon begin to display herd behavior in an attempt to cash in on the latest financial gold mine.

Stories of quick money made from flipping houses seen in the news buoyed individual and investor confidence which quickly paved the way for overconfidence. Investors overconfidence in the housing market raised their tolerance for risk; meanwhile, the rising profits and asset prices led to speculative behavior where economic decisions were increasingly based upon bravery and less upon sound economic and financial principles.

Historically, regional real estate bubbles have not been an uncommon occurrence; however, the scope, size, and longevity of the national bubble that existed between 2000 to 2007 had never before been witnessed in the American real estate market. It was argued that the existence and subsequent results of such a bubble...