How Do We Know When a Bubble is Fomenting?

Any economic bubble, whether it involves real estate or stock options, occurs when over-optimistic consumers invest more money in a commodity than the commodity is intrinsically worth. As market hype builds, consumers continue to invest in their over-valued commodity at increasingly inflated prices until - suddenly, like a bursting bubble - buying plummets. When a real estate bubble bursts, property market values drop dramatically as a reflection of demand until equilibrium is reached at which time market value better reflects actual property worth.

Is the Housing Bubble Fact or Froth?

Shortly before retirement, Federal Reserve Chairman Allan Greenspan acknowledged that the real estate market was optimistic. In a report to Congress he described the then-contemporary real estate market as rather "frothy" but nothing to be terribly concerned about. Some critics argue that by virtue of his office Greenspan refused to acknowledge the existence of an actual housing bubble for fear of spreading panic in the real estate market and insecurity in the general economy.

Housing Bubbles Happen Regionally

Housing bubbles form and burst within a regional context. While it is possible to conceptualize a viable "national" or "American" housing bubble within the context of an emergent globalism, it is easier to verify bubbles at increasingly local levels - neighborhoods, cities, or states. As of August 2007, homeowners in America's top 40 cities were warned to be on high alert for a housing bubble.

Beginning in 2006, Michael Corkery of the WSJ identified cooling market trends along the Florida coastline, in suburban D.C., and condominiums in the Palm Springs desert between California and Arizona. Investment banker John Talbott cites an average 47.2% decline of equity value in America's top 40 cities as evidence of a national trend. Property values in Boston have almost fallen by half. Miami and New York City have both seen a 44% decrease in property value and Chicago has averaged a 27.3% decline.

How to Avoid Getting Popped in the Bubble Burst

Consult your local market. Review real estate trends in your neighborhood and city to determine whether a potential equity liquidation merits selling your house while you still can. Economists and investors maintain that the best way to prepare for an imminent real estate bubble is to dump any investments in equity and reinvest net worth in cash. The strongest reinvestment in such a situation is the "nuclear bond option," where investors place a quarter of their total invested assets in each of the following sectors: Short Term Corporate Bond Index; Intermediate Term Bond Fund; Inflation Protected Securities Fund; and Money Markets or US Savings I-Bonds.