California is a great place to live. The weather is perfect all year round and everything is just a short drive away. But if you’re shopping for a house in the Bay Area, the high prices might turn you off. If you compare them to the less busy areas of US, you may not feel as confident settling down in California at all.
After the role of the housing bubble in the 2008 US Great Recession, everyone is terrified of investing in high-priced housing. Should you be worried?
Today, we’ll try to answer: “Will the housing market crash again?”
Is There A Housing Bubble?
The term “bubble” is a broad term, but it’s used more broadly by armchair economists.
Imagine that there’s a delicious cookie for sale. You want it, so you pay a dollar for it. However, your best friend wants the cookie, and he’s willing to pay you 2 dollars for it. You sell it to them.
Someone else hears about this amazing cookie, and they were willing to pay your best friend 5 dollars for it.
Someone noticed that people consistently want to pay more for the cookie, and they want to buy it so they can sell it for a higher price. However, he has no money on him. So he borrows 5 dollars from his older brother, promising 6 dollars in return. He buys the cookie for 5 dollars and sells it at 10 dollars.
Everybody heard about how this guy made 4 dollars from doing that, so everyone tried to squeeze the cookie for the most value they can get.
Eventually, the cookie gets passed around so much and it’s now valued at 50 dollars. However, nobody really wants to buy past 50 dollars anymore. Since there’s no more opportunity to sell for a higher price, people stopped looking at it as an investment. People only saw it as an overpriced cookie. However, the guy had to borrow a full amount of 50 dollars to pay for the cookie. What happens to him? He ends up with a dollar cookie and a 50 dollar debt.
That’s a bubble. Except in a bubble, there’s more cookies and more people in debts they can’t get back.
In a bubble, the cookie’s price and demand go up irrationally — as opposed to rational fundamental market factors like higher production costs, lower amount of customers, etc.
We partly talked about the housing market bubble in 2008 here. There were a lot of factors that made it into a bubble. However, some were bigger than the others, namely: the repeal of the Glass-Steagall Act in 1999, creation of CDO investments, and subprime mortgages. Banks and investors played around with the housing market, thinking it’s rock solid.
Is there a housing bubble in the Bay Area today? Nope. The prices are high, sure, but that’s a legitimate effect of a low supply and a high demand. We haven’t built enough housing, and people aren’t selling their houses because they’re not leaving California and they can afford their mortgage payments.
Will the housing market crash again? The housing market is cyclical — the prices will correct itself every now and then. However, it will NOT crash again at the same level of ’07 and ’08. It’s simply not the same market as it was back then.