Housing markets were unusually strong in the early 2000s, particularly in the United States. This was largely because of aggressive lending by financial institutions to fund house purchases, even to individuals with low or no income.
As a result, there was a rapid increase in house prices and new home building.
Residential property markets hit the wall during the global financial crisis as prices slumped and construction activity fell.
US house prices declined by 33 per cent between mid-2006 and mid-2011 and the number of new homes started plunged 72 per cent.
New Zealand house prices rose 12 per cent during the same period but the number of new dwelling consents fell by 54 per cent.
The slump in building was caused by falling house prices and the reluctance of financial institutions to lend to highly-geared property developers.
The situation has changed remarkably over the past few years as extremely low interest rates and aggressive marketing by financial institutions has stimulated demand, particularly from investors.
In just a few years we have gone from having an excess of new homes and limited demand to a a shortage of supply and heightened demand.
The demand is mainly driven by extremely low interest rates.
Central bank interest rates are 0 per cent to 0.25 per cent in the United States, 0.25 per cent in the euro area, 0.50 per cent in Britain, 2.5 per cent in Australia and 2.75 per cent in New Zealand.
Low interest rates over a long time do not automatically lead to housing bubbles, but they do create an environment where these bubbles can develop.
The New Zealand housing market, which was remarkably resilient during the global financial crisis, has picked up strongly in recent years.
Dwelling consents have increased from 14,124 in the the year to February 2012 to 21,842 in the year to last February.
The median house price has risen from $355,000 to $415,000 over the same two-year period although monthly sales figures have flattened out because of to the Reserve Bank's loan-to-value ratio (LVR) restrictions.
The bank describes these LVRs as speed bumps "designed to slow the growth in house prices and housing credit, and mitigate associated risks to the financial system and the broader economy".
The regulations require banks to restrict new residential mortgage lending at loan-to-value ratios of over 80 per cent (at least 20 per cent equity) to no more than 10 per cent of the total dollar value of a bank's new residential mortgage lending.
The Reserve Bank said the restrictions were introduced because of rising concerns about the housing market.
"Housing lending makes up more than half of all lending by New Zealand banks, and surging house price growth (particularly in Auckland) was judged to be contributing to an increasingly overvalued housing stock," it said.
"This leaves borrowers and banks exposed should house prices suddenly fall."
As more than half New Zealand's household wealth was in housing and household indebtedness was near record highs, "the ability of an indebted household sector to withstand a major decline in house prices was a serious concern".
"A much-extended house price boom that ended in a severe housing downturn could cause substantial damage to the financial sector and the economy."
The recent official cash rate increase from 2.5 per cent to 2.75 per cent and the LVRs will put a slight restraint on the domestic housing market but the only real solution is a significant increase in new housing construction, particularly in Auckland.
But this is not occurring because property developers are less confident about the long-term future of the housing market, and are finding it more difficult to borrow, than residential property investors.
Sales remain high in Australia, particularly in Sydney and Melbourne. Sydney house prices have risen 15 per cent over the past 12 months and Melbourne 12 per cent.
OECD statistics show Australian house prices are overvalued on a price to income basis - as are New Zealand house prices - but this can change rapidly.
Irish house prices were assessed to be substantially overpriced in 2007 but they have since fallen 45 per cent and are now considered to be undervalued even though they have picked up 8.5 per cent over the past year.
The British housing market continues to attract bubble headlines including "Housing bubble forming in London" and "Housing bubble fears grow as UK property price recovery gathers pace".
Ernst & Young believes the London housing market is showing "bubble-like" conditions and the independent think-tank Civitas says restrictions should be placed on overseas buyers of London property.
Civitas says the British property market is being used as an investment vehicle by the global super-rich while hundreds of thousands of younger residents are being priced out of the market and rents are consuming more and more of their income.
Many of these super-rich are from China which is also receiving a huge amount of property bubble speculation.
The problem with China is that the country's economic data is unreliable. Modern China has only 20 years of history, which is insufficient to establish how it will respond to a property downturn, and Chinese investment behaviour may be different to the western world.
There is a strong argument that the Chinese see property investment as a store of value whether it is in China, London, Sydney or Auckland.
As China has no national pension or benefits, many investors may see property as the backbone of their long-term protection plan.
Property could be the equivalent of gold for Chinese investors because they are not concerned about the income they derive from this investment.
This argument is often used to justify the huge amount of unoccupied residential property owned by Chinese investors at home and around the world.
The other argument is that the Chinese Government can bail out a depressed property sector because it effectively controls the major banks.
It would be nice to believe that the world was as simple as that, but the Japanese property boom and bust in the late 1980s is a stark reminder that property bubbles can have a long-lasting negative effect on an economy.
It is difficult to know whether all these bubbly stories are justified but the one thing we can say with certainty is that investors will be on "property bubble" watch, particularly as far as China is concerned.
• Brian Gaynor is an executive director of Milford Asset Management.
