(Don’t be) bad at math

Take a look at the figure below, which shows one way of looking at the housing bubble. The graph shows the ratio of the “median home price to medium household income.” Notice that this ratio remained close to 3 for decades, meaning that on average, a family with income of $50,000 per year would purchase a home costing about 3 times $50,000, or $150,000.

Then, from about 2001 to 2007, the ratio shot up to almost 5, meaning that the same average family was suddenly spending close to $250,000 on a house. How was it possible that the same income suddenly have allowed a family to purchase a much more expensive home? I won’t go through the full analysis here, but the basic answer is: it wasn’t, and anyone who thought it was simply ignoring basic math.

In other words, the bubble occurred because people purchased homes they couldn’t really afford, and this fact would have been obvious if Americans, as a nation, had simply paid more attention to the math.

From Math for Life (Big Kid Science, 2014). Data used with permission of the Joint Center for Housing Studies of Harvard University. All rights reserved.

Lest you think that this is a case of hindsight being 20/20, keep in mind that these kinds of data were available throughout the growth of the bubble. Anyone willing to think about it should therefore have known that the bubble would inevitably pop, and, indeed, you can find many articles from the time that pointed out this obvious fact.

(Next page: So how did everyone else manage to miss it?)

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