I think one of the points I'm trying to make about bubbles is getting lost in all the back and forth:
Bubbles are fundamentally irrational events.
Now, even slight shifts in demand in an inelastic housing market will cause home prices to rise. They're supposed to rise; that's a simple matter of supply and demand, first-day economics stuff. But a sharp rise in prices does not a bubble make. Bubbles occur when an asset's price rises above its fundamental value. In an inelastic market like LA, this means: Prices first rise because of a shift in demand -- basic economics -- but then take off from there as the mass delirium that causes a bubble takes hold.
I don't think the sharp price increases in central LA, San Diego and DC could be justified by any rational valuation of homes as capital, income-producing assets -- although they certainly could have triggered frenzied investment by new investors. I instead claim they were bubble prices and therefore had to crash. This crash had to happen regardless of the strictness of land-use regulations because even land-use regulations cannot sustain prices (long-term) above a rational value.
But let's suppose I'm wrong and that all price increases were caused by a shift in demand in an inelastic market. The principle works in reverse, too: Slight shifts downward in demand cause steep drops in prices. Since there's no question that the collapse of the subprime markets caused a drop in demand, these inelastic markets had to see a steeper decline in prices than inelastic markets, at least if you accept basic principles of supply and demand.
Supply-and-demand does not tell you where the price increases decreases will be steepest within a metropolitan area, but the price declines ultimately must be blamed on supply inelasticity.
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