I have been in the Real Estate industry for about thirty three years, I don’t think I am the smartest Broker living, but I’ve seen my share of crazy markets and associated terminologies.  The later part of 05 is when I first heard the term “real estate bubble”.  I have to admit, I actually did a double take as I listened to the news that evening.  So exactly what is a bubble, how do you know when you are in a bubble, how do you know if the bubble is about to burst?  
You could say a bubble is sort of like pornography; everyone has an opinion of what it is, but impossible to pen a definition to it.  I guess the old saying they used in Congress once, you’ll know it when you see it, may be true.

In the economics profession bubbles can be embarrassing, its not that we have no idea what causes bubble to form, it’s that we have too many ideas for comfort.  There are those who will tell you that bubbles are merely psychological.  Others will tell you that bubbles are stoked not by markets but by governments.  Then we have the one unexplainable theory that some of the most famous bubbles weren’t bubbles at all.

I would think the psychological explanation would be the easiest to explain:  People get carried away to easy; they tend to follow the crowd.  They hear stories of their neighbors getting rich and they want a piece of the action.  They are easily led to believe that somehow, the price of stocks (1929) or dot-com start-ups (1999) or real estate (2006) can only go up, so they all want a piece of the pie.  Now it becomes a feeding frenzy that begins to get larger and larger, thus the bubble effect forms. Economist would call this the “herd instinct”.  History teaches us though that most herd instincts seem to cost us money in the long run.  

Herd instinct can be seen even in mob or riot situations, people begin to follow others and mimicking those in front of them.  How many times have you seen people jump on a band wagon if they think there are profits to be made?  Someone in the office has a “hot stock tip”, now the majority within the office wants to get their shares, no research or study of the product, hurry we can’t wait any longer, got to have it. This usually will end up costing us in the long run.

There are many motivators to cause a bubble.  The fear of being too late and there won’t be any left is one fear that a lot of women fall into when shopping, we have to hurry to down to xyz department store for the sale, hurry, I know it’s four in the morning, but the store opens at nine and we don’t want to be late, and we want to be first in line.  

Our housing and financial bubble goes a little deeper then just too many people wanting their piece of the pie though.  The government played its own part and is to shoulder the majority of the blame.  The Federal Reserve’s policy of cheap money, Fannie and Freddie’s enormous appetite for junk mortgages—urged all the way by politicians trying to make credit available to poor and risky borrowers.  
Bubbles all have their own engines to power them; it could be fraud, greed, perverse incentives, mob psychology and government incompetence.  We should all understand one thing though, no matter how much hysteria there is the bubble will only get so big before it begins to deflate at some point. It is then the cold hard awakening to reality sets in, but by then our money is usually gone.  In the future if you hear of something that is just too good to be true, remember what my grandmother would say, it is too good to be true, turn around and run.