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Defining Bubbles

Posted By Barry Ritholtz On March 16, 2005 @ 6:40 am In Markets | Comments Disabled

The Nattering Nabob [1] has a very pithy (and astute) observation of what makes a bubble:

Manias share four common characteristics:

• A feeding frenzy sends prices parabolic.

• The public jumps in with both feet.

• Valuations detach from economic reality.

• Rationalizations abound for why valuations are reasonable and the trend will continue.

There are several reasons I have been reluctant to call the Real Estate market a bubble — yet.

- The market is regional; San Francisco, NY and Boston do not = the entire US;
- Its an illiquid market, and properties take a while to sell (as opposed to being flipped intraday);
- Most buyers care little about purchase price — they are concerned with monthly carrying costs. Insurance and Taxes have remained fairly stable;
- 40 year low interest rates allows people to buy more expensive homes, so long as they can afford the monthly nut.

I do expect the hottest areas to fall by as much as 30%, if rates keep rising (as many expect they will) . . .  Is that a bubble popping — or merely a retracement of outsized gains?

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[1] Nattering Nabob: http://naybob.blogspot.com/2005/03/us-housing-valuation-now-140-of-gdp.html

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