A housing bubble is a run-up in housing prices fueled by demand, speculation, and exuberance. Housing bubbles generally start with an increase in demand, in the face of inadequate supply which takes a relatively long period of time to replenish and amplify. Speculators enter the souk, further driving demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices — and the bubble bursts.
Conventionally, housing markets are not as prone to bubbles as other financial markets due to the large transaction and carrying costs related to owning a house. However, an amalgamation of very low-interest rates and a loosening of credit underwriting standards can bring borrowers into the market, fueling demand. A rise in interest rates and a contraction of credit standards can lessen demand, causing the housing bubble to burst.
Adjustable-rate mortgages began resetting at higher rates as cryptogram that the economy was slowing emerged in 2007. With housing prices teetering at lofty levels, the risk factor was too high for investors, who then stopped buying houses. When it became evident to home buyers that home values could actually go down, housing prices began to plummet, triggering an enormous sell-off in mortgage-backed securities. Housing prices would eventually turn down more than 40% in some regions of the country, and mass mortgage defaults would lead to millions of foreclosures over the next few years.
The questions of whether real estate bubbles can be identified and prevented, and whether they have broader economic significance are answered differently by schools of economic thought. The financial crisis of 2007–08 was related to the bursting of real estate bubbles which had begun during the 2000s around the world.