Home ownership…the cornerstone of the American Dream and the biggest-ticket item on most American balance sheets…has been a primary reason our economy has not tanked during the past two years. Americans have not stopped buying homes, leading many who follow markets to believe that we may be headed for a housing bubble.

I suspect there may be some truth to the idea that a real estate bubble is forming, raising the potential for a future fall in real estate prices.

Housing markets are driven by demographics. A younger population, with lower income characteristics will want first, or starter homes. They will borrow like crazy to buy that first house. As their families and household incomes grow, so will their desire for more space and nicer accommodations, propelling demand for larger, nicer homes. For most families, the move-up homes will be the largest, most expensive homes they will own.

Eventually the kids are weaned from the family refrigerator, leave home, the pet dies, and now mom and dad are ready for newer, more manageable digs…but first they have to sell the empty castle.

Here’s the rub. If they are planning to sell that big home, at the same time all of their cohorts are thinking likewise, there could easily be an oversupply of large, expensive homes on the market…and not enough young buyers coming along to pay today’s prices for the larger homes.

That is exactly where we are with American demographics. The biggest demographic wave of history…baby boomers born in the late ’50s and early ’60s, augmented by a huge immigration wave of like-aged immigrants in the late 1980s…is buying the big homes today. Tomorrow they will be selling them.

When that happens, the bubble will pop!

The great bull market of the 1990s left many with the impression they would live out their lives with their stock portfolio in the family castle. The great bear, busily devouring portfolio gains of the ’90s, is changing the rules. Instead, it is the wealth locked into the value of the castle that many expect will pay for their retirement years. To realize that value they will have to sell and downsize.

Again, we have to look at the numbers. If all the cohorts of this generation begin selling the larger homes and buying smaller homes…expect prices to fall on the high end and go up in the retirement-style sector.

According to an article in Barron’s, real estate wealth grew $2 trillion between the first quarter of 2000 and the fourth quarter of 2001. This helped offset the $3.9 trillion decline in household stock-market investment over the same period.

Low interest rates have allowed Americans to tap this wealth through refinancing and new home ownership. Not only did the lower interest rates save Americans an estimated $15 billion or so in annual debt service (Barron’s estimate), but it also allowed an additional $80 billion or so to be pumped back into the spending stream.

Whether this offsetting wealth and spending strength can continue is a matter of some debate among economists. Those who follow California real estate, for example, acknowledge the boom and bust cycle, but they will be the first to remind you that real estate always comes back in the Golden State.

This may be so, but I tend to believe that in the end it is demographics that will make the rules…and right now it might be a good thing to remember that timing is everything.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.