The US Housing Bubble — the belief that house prices could only rise

In the United States between roughly 2000 and 2006, the price of the typical American house nearly doubled, propelled by an almost universal conviction — held by borrowers, lenders, rating agencies, regulators, and the largest banks on Wall Street — that house prices could not fall nationwide. That conviction collapsed in 2007–2008. The S&P/Case-Shiller national home price index, which peaked in the first quarter of 2006 at about 198, fell to roughly 114 by early 2012, a decline of more than 40 percent from peak to trough, and the financial machinery built on the assumption of ever-rising prices failed catastrophically.

The delusion was not chiefly about flowers or tulips but about correlation. Lenders extended mortgages to borrowers who could not plausibly repay them — the subprime loans that grew from about 5 percent of originations in the mid-1990s to roughly 20 percent, around $600 billion, by 2006 — because the loans were not meant to be repaid so much as refinanced or sold. Wall Street pooled those mortgages into securities and sliced them into tranches, and the rating agencies blessed the senior pieces as nearly riskless on the statistical premise that home prices in different regions would not all fall at once. They did all fall at once.

When prices turned in 2006 and defaults rose, the chain ran in reverse. In 2007 two Bear Stearns hedge funds invested in mortgage securities imploded; through 2008 the losses spread until the investment bank Lehman Brothers filed for bankruptcy on 15 September 2008, the largest such filing in US history, and the global financial system seized. US household net worth fell by an estimated $13 trillion; foreclosure filings surpassed 3 million in 2008 alone; and the recession cost roughly 9 million jobs. The episode proved a mania need not be confined to amateurs: the most sophisticated institutions in the world, armed with risk models and credit ratings, talked themselves into the same single error — that the thing going up would keep going up — and built a global edifice of leverage on top of it.