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186 PART 2 • Producers, Consumers, and Competitive Markets
E XA MPLE 5.7 THE HOUSING PRICE BUBBLE (I)
Starting around 1998, U.S. housing prices began rising sharply.
Figure 5.10 shows the S&P/CaseShiller housing price index at the
national level.20 From 1987 (when
the Index was first published) to
1998, the index rose around 3 percent per year in nominal terms. (In
real terms, i.e., net of inflation, the
index dropped about 0.5 percent per year.) This
was a normal rate of price increase, roughly commensurate with population and income growth and
with inflation. But then prices started rising much
more rapidly, with the index increasing about 10
percent per year until it reached its peak of 190 in
2006. During that 8-year period from 1998 to 2006,
many people bought into the
myth that housing was a sure-fire
investment, and that prices could
only keep going up. Many banks
also bought into this myth and
offered mortgages to people with
incomes well below what it would
take to make the monthly interest and principal payments over
the long term. The demand for housing increased
sharply, with some people buying four or five
houses under the assumption that they could “flip”
them in a year and make a quick profit. This speculative demand served to push prices up further.
However, in 2006 something funny happened.
Prices stopped going up. In fact, during 2006, prices