beersheba real estate 311.
(photo credit: Courtesy)
In recent months there has been much discussion about whether Israel is
experiencing a real-estate bubble. The Bank of Israel has expressed concern over
the continuing rise in the prices of apartments, and last week Bank of Israel
Governor Stanley Fischer said the central bank would intervene if there are no
signs of price stabilization.
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What are bubbles, why are they bad, and how
can their damage be prevented or mitigated?
If we understand why markets usually
work well, we can better understand why sometimes they don’t. The great thing
about markets for ordinary goods and services is that every person needs to know
only things that he is expert in, and the price system aggregates that
information into an outcome that is good for everybody. Each consumer knows best
what goods and services he needs and can afford, and each business establishment
knows best what goods and services they are in a position to provide.
market price will take into account the supply and demand of each individual
“expert” and stabilize the market. If the price is too high, then vendors will
find there are no customers. If the price is too low, then they will have lines
around the block. Prices naturally adjust to a stable level.
financial assets are not bought for consumption now, but rather for their
monetary value in the future. One problem is that the average citizen is not an
expert on financial instruments. But a more fundamental problem is that even a
true expert does not really know much about them.
The value of an
investment depends on the performance of the individual asset and the economy as
a whole in the future, and no one really knows what the future will
bring. Furthermore, people are not interested in what the asset is going
to be actually worth, but only what other people will be willing to pay for it.
That means that in financial markets, people spend a whole lot of time looking
over their shoulders wondering what other people think of asset
This guessing game can make financial markets very unstable. In
goods markets, a rise in prices consistently reduce demand because it means that
prices now exceed the inherent value of the good. But in financial markets,
price rises can increase demand because they demonstrates investor
interest. One price increase can lead to another.
In the 18th
century this phenomenon was described as a “bubble.” The term is fitting: Market
bubbles get bigger and bigger in market value, but they are filled with mere air
– with people’s expectations of future price rises. And like bubbles, ultimately
these price expansions must burst.
It’s not unlike a Ponzi scheme, where
each person who buys in believes he will be able to sell at a profit to some
future investor. But eventually the market must run out of new buyers and the
Such a bubble is bad for the economy in many ways. The
first problem is the mispricing. If tulip bulbs (17th century Holland),
or Internet companies (the 1990s), or apartments in Nevada (in the years
preceding the recent crash) are overvalued, then the price system isn’t working.
The resources devoted to these sectors exceeds their true contribution to the
economy. And if the bubble is of large proportions, it can threaten the
stability of the entire economy.
A bursting bubble leaves people with
greatly reduced wealth and thus greatly reduced demand. The result can be a
general recession, not just a healthy downturn in the particular sector that was
Apartments share attributes of both kinds of
markets. On the one hand, each family knows best what kind of apartment and
neighborhood suits its needs and its budget. But houses are also bought
as an investment and with an eye to resale value, so the housing market is not
immune to bubbles. Indeed, many researchers believe a housing bubble made
a major contribution to the financial crisis that shook the world economy two
But agreeing that a bubble is bad is easier than agreeing one
exists. Are people paying more for apartments in Israel now because they believe
that they will be able to sell them for even more in the future? Or do they have
fundamental reasons for bidding up the prices? Perhaps people foresee a wave of
aliya, or increased government aid to home buyers?
And agreeing that one exists
is easier than stopping its growth. Will the effect of restraining measures by
the central bank be limited to keeping real-estate prices from spiraling out of
control, or will they restrain activity throughout the economy, or perhaps
create a bubble somewhere else?
These questions do not necessarily need firm
answers. No one can be sure that there is a bubble, and no one is sure that
restraint will keep one under control. But since the likelihood exists, and
since the potential damage is great, the monetary authorities feel that simple
prudence calls for measures that will moderate increases in real-estate
email@example.com Asher Meir is research director at the
Business Ethics Center of Jerusalem, an independent institute in the Jerusalem
College of Technology (Machon Lev).