Saturday, May 11, 2013

Economic Bubble

What Is A Bubble?
A bubble can form in economies, securities, stock markets and business sectors because of a change in the way that people conduct their businesses. For example during the tech boom people bought tech stocks at high prices believing that they could sell those stocks at an even higher price until they lose their confidence is lost and a large market correction or crash occurs. The same can be seen in the recent housing crisis. For years the prices of homes were rising and people thought that they would continually be an investment that would increase in value, so people took out home loans and invested in houses. However when there was a large influx of houses on the market it drove the price of houses down and the market crashed causing people to default on their loans resulting in a financial crisis as well. An economic bubble can also be described as a surge in a market caused by speculation regarding a commodity which results in an increased level of activity in that market which causes over-inflated prices.
Economic Bubbles In U.S. History
The United States housing bubble is one tat still lies in the minds of countless Americans who were effected. Housing prices peaked in the U.S. in early 2006 and then started to decline in 2006/07. In 1990 the average price of a U.S. home was priced at $149,800. There were many reasons that the housing bubble burst. In 1997 the Taxpayer Relief Act offered tax relief for people on the profits that were gained from the sale of a person's residence. People started investing in second homes and investment properties to take advantage of this. The Taxpayer Relief Act of 1997 made housing the only investment which escaped capital gains (the Taxpayer Relief Act gave single individuals $250,000 exclusion of taxes on capital gains and $500,000 for married couples). The Taxpayer Relief Act encouraged people to buy expensive, fully mortgaged homes as well as invest in second properties instead of investing in stocks, bonds, or other assets.
There were many other sources of the housing bubble that burst in 2007 which I will talk about in a later article that gives a more in depth description of the housing crisis. However the result was that people instead of putting their money in savings put their money in large housing investments beyond the amount of money that they currently held. The thought was that with the prices of housing appreciating (increasing in value) they would be able to pay off the large investment easily. However as housing prices started to decline in late 2006 the return on these investments decreased. A stipulation in the loans that people were taking out to invest in these expansive houses was that the house would serve as collateral if the person were to default on their loan so the bank would win no matter what because they had confidence that the housing market would continue to improve and the house that served as collateral would appreciate in value. However as the value of housing decreased consumer confidence in the housing market was lost and many people defaulted on their loans causing many home to go on the market thus decreasing the prices of houses further.

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