The Great Collapse Part I: Housing Never Goes Down

So the whole crazy mess the financial system is in just now can largely be traced to the collapse of the housing bubble.

What, you might ask, is a housing bubble? Or maybe even just "what is a bubble"?

A bubble, dear friend, is when a market decides to go a little "irrationally exuberant" (in Alan Greenspan's memorable phrase, used to great effect as the title to Robert Shiller's book on the stock market bubble of the late 90's. I mention Shiller as he is the current expert on bubbles and because I had a conversation with him once when I was considering pursuing an Econ PhD. Then I remembered that I hate school. But he was still interesting to talk to.).

What this means is that whatever the focus of the bubble is: stocks, bonds, housing, famously, once, tulips; gets bid up. People start buying it not because they need it or because they feel it's worth the price they're paying but because they feel the price will continue to go up so they'll make money that way. And for a while, at least, they're right.

So. The housing bubble. What happened there? Basically, in much of the country, for a prolonged period of time, housing prices went up. And up. And up some more. They went up quickly. And then did it again. For years.

Over time, humans being what they are, this began to seem normal. If house prices go up 15% a year for 15 years, who's to say they won't just keep going up 15% a year forever?

Sensible people, that's who, but those are always in short supply and particularly so during bubbles and their inverse, panics. (Panic, by the way, often accompanies the collapse of a bubble, so expect to hear more about our old friend panic when we get to the later parts of this series...)

So where were we? Ah yes, otherwise sane-seeming people began to treat housing prices as if they were just going to keep going up forever. What happens when something's price goes up forever? All kinds of wonderful things, for the right people.

If you sell that thing, for example, it can be even easier to sell it. Because now you have a huge selling point: buy this thing now and reap the gains that are coming! The sooner you buy the more the gains!

People start buying into this logic and doing whatever they can to jump in. Or jump in again by buying second homes or other "investment property". Pretty soon, you have people buying and selling places without ever living them or, in some cases in condos in Florida that I know of specifically, even seeing them. You literally have new developments where the apartments are sold and resold multiple times before the building is finished and before any one moves in.

This, dear friend, is the equivalent of a market putting up a giant neon sign that flashes "BUBBLE!!" all day long but, again, in the heat of a bubble no one wants to pay attention to signs that it's a bubble. After all, everyone's making a killing and who wants to say it's over?

The point is, that a bubble can begin to drive increases in its own demand. People see people like them making money by flipping houses or stretching to buy a house just out of their means and they want in. When more people want in, that means you've got more people bidding, which means you've got rising prices. Wash, rinse, repeat.

But how can people afford to buy lots and lots of very expensive things like houses?

Well, how can anyone who's not filthy rich ever afford to buy expensive things like houses? You borrow the money!

When you borrow money to buy a house, as everyone knows, it's called a mortgage.

So stay tuned for part two, when we delve into the fascinating details of the mortgage market, including the magic of "mortgage securitization"...

No, really, it's fascinating. Of course, I read economic history for fun, so take that into consideration when I call something "fascinating".