Leir Center For Financial Bubble Research Working Paper #6

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3.2.4 The Fourth Stage - The Re-entry of Non-speculators

Eventually, the stability of the market price relies on the number of non-speculators, m, that re-enter the market. Despite the decreases of x and the increase of n or h, if m increases enough, will hold again, and the market price will return to the new steady state, which is the fourth stage of a bubble. If c continues to decrease or even to reach zero and/or no speculators are left in the housing market, the steady state determined by the non-speculators will become a new bench mark for another bubble to begin in the future.

3.3 The Crash

Unfortunately, when c continues to decrease, it may also become negative if the speculators become pessimistic. This may also impact the non-speculators as well. Then from horizontal aggregation, there will be another kink of the demand curve, which leads to a lower price than the original benchmark price. It is possible that all the speculators have exited the market, not because they have sold their houses, but because they choose not to buy any more houses. Or they are simply trapped with the houses that they cannot sell. They can even face foreclosure problems if they have liquidity problems paying their mortgages. For non-speculators, they can also be waiting for the housing price to go even lower. This is why a crash usually follows a bubble due to the combination of increased supply and decrease in demand after a bubble bursts. Once again, if even x = 0, if m is large enough, the market price will become stable again, with probably a lower steady-state price than the original benchmark price in stage 1. Then the new steady-state housing price will become the new benchmark for anther bubble to begin in the future. Such a price movement can be observed in Figure 1 of this research. One additional problem, however, is that banks may not be willing to lend and/or can apply stricter standards for homebuyers to get a mortgage. Therefore, if lenders are reluctant to begin lending, government support as a lender of last resort may be required.

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