In December 1996, Alan Greenspan, as chairman of the US Federal Reserve Board, coined the term ‘irrational exuberance’ to describe the behaviour of stock market investors during the 1990s. His use of these two words was immediately followed by stock market slumps: in Japan the Nikkei index dropped by 3.2%, in Hong Kong the Hang Seng lost 2.9%, in Germany the DAX index fell by 4% and in London the FT-SE 100 was down by 4%. The next morning in the United States, the Down Jones Industrial Average decreased by 2.3% in early trading. A decade later, Shiller (2005) reported that people were still referring to ‘irrational exuberance,’ since this phenomenon had occurred again and again in different forms. During the late 1990s and 2000s, it became a catchphrase associated with bubbles, including housing bubbles. Case and Shiller (2003) p.299 state that in general and everyday use, the terms ‘bubble’ or ‘housing bubble’ refer to situations “in which excessive public expectations of future price increases cause prices to be temporarily elevated,” indicating that the concept is defined in terms of people’s thinking, their expectations and assumptions about future price performance, their theories regarding the risk of falling prices, and their worries about being priced out of the housing market in the future if they do not buy now. McCarthy and Peach (2004) present a simpler analysis: the rapid increase in national house price series counts as prima facie evidence of a bubble. However, such increases alone are necessary but not sufficient evidence; a deeper analysis is required.
Barlevy (2007) points out that the mass media often uses the term ‘bubble’ to describe a market condition in which the price of an asset has increased considerably in such a short period of time so as to suggest that the price is vulnerable to an equally sudden collapse. Shiller (2005, cited in Wanfeng, 2011, p.5) refers to the contribution of the mass media with respect to bubbles, citing a ‘‘price increase driven by irrational euphoria among individual investors, fed by an emphatic media, which maximized TV ratings and catered to investor demand for pseudo-news.” Farlow (2004) claims that during a bubbly housing market, any evaluation of what is going on tends to become out of date and muted. During bubbles, the media have developed the habit of referring to those who continue to promote optimistic views as ‘housing market experts,’ while those holding more cautious views are called ‘housing market doomsayers.’ It seems that such behaviour on the part of the media is in the nature of a housing bubble. Another notable trend during housing bubbles is that homebuyers believe that a home that they would normally consider too expensive becomes an acceptable purchase due to the prospect of significant future price increases. As a result,
homebuyers feel they do not need to save as much as they otherwise might, because they expect that the rising value of their home will do the savings for them. First-time homebuyers may also worry during a housing bubble that if they do not buy now, they will not be able to afford a home later (Case & Shiller, 2003)
Case and Shiller (2003) observe a tendency during a housing bubble for market participants to view housing as an investment. Expectations of future capital appreciation are a motive for buying a home, while considerations of how much one must pay for housing services are ignored. The authors argue that this “is what a bubble is all about, buying for the future price increases rather than simply for the pleasure of occupying the home” and that “there is a tendency to crash when the investment motive weakens” p.321. Shiller (2000, 2002) further describes a bubble as ‘‘a social epidemic period of feedback, where price increases present stock prices could contain bubbles…enthusiasm among investors, who then bid up prices more, and then it feeds back again and again until prices get too high. During that period, people are motivated by envy of others who made money doing it, regret in not having participated and the gambler’s excitement. Stories develop that justify the bubble, they become current and then people think they’re right because everyone’s confirming the stories. So, when that happens eventually prices get too high and the bubble bursts.’’
Shiller (2000, cited in Farlow, 2004, p.4) notes that the “absurd prices sometimes last a long time,” indicating that even when prices converge, the process might not be smooth or short. Tirole (1982, cited in Barlevy, 2007) likens investment in a bubble market to a game of ‘hot potato,’ in which each investor tries to pass an overvalued asset to the next investor to make a profit at the expense of the next buyer. If there were infinitely many investors, each trader would never run out of prospective hands into which to pass the hot potato. However, since the market has a finite number of buyers, it is not possible for everyone to find a buyer and avoid getting stuck with the hot potato. Similarly, Moinas and Pouget (2010) note that the main element in the existence of a rational bubble is that market participants can never be sure whether they will be last in the sequence.
Case and Shiller (2003) cast light on the description of the phenomenon by mentioning that the term ‘boom’ is much more neutral than ‘bubble’ and suggests that the rise in prices may provide an opportunity for investors. In other words, from the point of view of investors, a booming market offers the opportunity to make future profits. Conversely, the use of the term ‘bubble’ implies a negative judgment on the phenomenon of rising prices, or the view that the current price levels cannot be sustained, at least not for very long. Also, in a
graphical illustration, Case and Shiller (2003) show that a boom is the peak point of house prices, while a bubble is the process underlying the boom.