There may be no more subject more illuminating that the current real estate bubble and the related problems that it has spawned. I am going to offer my thoughts on this subject in two parts, what was and what is to contrast the differnce in thinking that has lead to a disconnect.
Residential home purchases, in my view, historically were a sort of forced savings plan most benefiting people without access to major anounts of capital (not alot of cash) and people with limited investment opportunities (not alot of cash, perhaps no 401K, etc.). A couple would buy a home, pay down the mortgage, and after a while, they had built up equity in the home that could be used at a later date as needed. There are tons of debateable benefits of home ownership (stability, tax breaks, not paying a landlord, etc) but for this discussion they dont matter. A home was viewed as a place to live, as well as a way to build a financial nest egg for a later date.
Home purchases have become the newest and most dangerous speculative plays since the Dot com era of 2000. Homes have been purchased not for a long term investment, but as a get rich quick scheme. I will not go into the particulars in depth, there are plenty of blogs and sources that can better articulate the process better than mine (read the blogs over on the left panel). For my discussion purposes what I want you to take away is that from about 2002 to late 2006 the vast majority of home purchases were made not to invest long term but to make a killing short term.
Where We Are
Currently we are at a point where home prices are so out of line with incomes and reality that a historic price correction has just begun. Not since THE GREAT DEPRESSION have home prices declined on a national basis, but they are falling right now. The news is filled with details of record foreclosures, subprime mortgage meltdowns, and collapsing home prices in hot market areas like Las Vegas and the Florida coast. To get an idea of what happened, take a long look at the Case-Shiller index at the top of this post (from the NY Times 9-26-07). The big disconnect in real estate was that prices cannot go up forever. Incomes have no way to keep pace with home prices, only exotic mortgages and the entrance to the market place of rampant speculators drove prices up. Now that banks and mortgage companies are getting hit with huge losses, we will now see the disconnect unravel and reality return. It will not be pretty.