Subscribe to this blog's feedAlea points to a short and highly readable paper that describes why bubbles happen in property: it's an illiquid, opaque market that's difficult to short and suffers from infrequent, highly disruptive crashes, and that tempts banks into making lots of leveraged loans... also a very interesting aside on the subject of disaster myopia.
Moreover, in the absence of appropriate provisions for potential losses, an activity subject to low-probability shocks will appear misleadingly profitable. This problem is often compounded by the practice of recognizing fees (which may be considerable in some lines of real estate finance) up front, when the loan is booked, rather than amortizing them over the life of the loan... The illusion of high profitability creates additional problems. To the extent that salaries and bonuses are based on reported short-term profits without adjustment for reserves against shocks, the line officers who are in the best position to assess such dangers will be rewarded for disregarding them.
