An Examination of the Reno Sparks Real Estate Bubble
AuthorHarrison, Brandon M.
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The recent trends witnessed in home prices at the local, state and national level have led to the near consensus conclusion that the US has experienced a housing bubble. While many formal definitions of a bubble exist, the common concept is that a bubble forms when the actual market price increases above the "fundamental" price, which is a price that can be rationalized from factors that would normally be expected to affect the market price. In the case of the price of housing, the development and subsequent bursting of a bubble has dramatically impacted the economy, leading the US to the most the most severe recession it has experienced since the early 1980s. Thus, it is important to examine how the bubble might have formed, so policies can be adopted that make bubbles less likely in the future. The focus of this thesis is the metropolitan statistical area of Reno-Sparks, Nevada. The pre-bubble housing trends within the Reno-Sparks MSA are examined, as well as the "fundamental" factors that typically affect ("fundamental") prices. Theory is reviewed that offer explanations for how bubbles might form, which offers insight as to how to test for them. The roles of sub-prime adjustable rate mortgages and the federal government in creating the bubble are discussed. We find the Reno-Sparks MSA did experience a bubble, caused primarily by a reduction in the perceived risk of holding mortgages for investment purposes. The development of mortgage backed securities (which diversified the risk) and the development of a secondary market for mortgages (which enabled mortgage originators to quickly shift the risk to others) were the primary causes of this change in perception. The perceived reduction in risk, along with loose monetary policy, provided an environment where the demand for housing increased for both investment and consumption purposes, prompting self fulfilling price expectations. Recommended institutional reforms are the implementation of a holding period for mortgage originators, the prevention of banks from dealing in complex derivatives, and policies that would prevent financial institutions from becoming "too big to fail.