186 PART • Producers, Consumers, and Competitive Markets E XA MPLE 5.7 THE HOUSING PRICE BUBBLE (I) Starting around 1998, U.S housing prices began rising sharply Figure 5.10 shows the S&P/CaseShiller housing price index at the national level.20 From 1987 (when the Index was first published) to 1998, the index rose around percent per year in nominal terms (In real terms, i.e., net of inflation, the index dropped about 0.5 percent per year.) This was a normal rate of price increase, roughly commensurate with population and income growth and with inflation But then prices started rising much more rapidly, with the index increasing about 10 percent per year until it reached its peak of 190 in 2006 During that 8-year period from 1998 to 2006, many people bought into the myth that housing was a sure-fire investment, and that prices could only keep going up Many banks also bought into this myth and offered mortgages to people with incomes well below what it would take to make the monthly interest and principal payments over the long term The demand for housing increased sharply, with some people buying four or five houses under the assumption that they could “flip” them in a year and make a quick profit This speculative demand served to push prices up further However, in 2006 something funny happened Prices stopped going up In fact, during 2006, prices 190 Home Price Index 170 Housing Price Index (nominal) 150 130 110 90 70 Housing Price Index (real) 50 1987 1989 1991 1993 1995 1997 1999 Year 2001 2003 2005 2007 2009 2011 F IGURE 5.10 S&P/CASE-SHILLER HOUSING PRICE INDEX The Index shows the average home price in the United States at the national level Note the increase in the index from 1998 to 2007, and then the sharp decline 20 The S&P/Case-Shiller index measures the change in housing prices by tracking repeat sales of single family homes in 20 cities across the United States By comparing a home’s original sale price with its price in subsequent sales, the index is able to control for other variables (i.e., size, location, style) that might also lead to rising home prices