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Real Estate Bubbles and Urban Development

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  • Edward L. Glaeser

Abstract

Why are real estate bubbles so common? Can these bubbles actually do some good? Real estate booms have regularly occurred throughout the world leaving painful busts and financial crises in their wake. This paper suggests that real estate is a natural investment for more passive debt investors, including banks, because real estate’s flexibility makes it better collateral than specifically built production facilities. Passive capital’s preference for real estate will be particularly strong when agency problems bedevil equity investments. Consequently, passive capital may flow disproportionately into real estate and the errors of passive capital can generate real estate bubbles. The preference of banks for more fungible real estate assets can also explain why real estate is so often the source of financial crises. In principle, real estate bubbles can be welfare enhancing, if cities would otherwise be too small either because of agglomeration economies or building restrictions. But given reasonable parameter values, the large welfare cost of any financial crisis associated with a real estate bubble is likely to be much higher than the modest benefits of extra building. The benefits of real estate bubbles are welfare “triangles” while the costs of widespread default are welfare “rectangles,” which is why bubbles rarely appear to be benign events.

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  • Edward L. Glaeser, 2016. "Real Estate Bubbles and Urban Development," NBER Working Papers 22997, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:22997
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    2. Franklin Allen & Xian Gu, 2018. "The Interplay between Regulations and Financial Stability," Journal of Financial Services Research, Springer;Western Finance Association, vol. 53(2), pages 233-248, June.
    3. Joe Peek, 2018. "Comments on “The Interplay between Regulations and Financial Stability”," Journal of Financial Services Research, Springer;Western Finance Association, vol. 53(2), pages 249-254, June.

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    More about this item

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • R10 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General
    • R30 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - General

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