Shiller argues that the decade-long run up in housing prices was a bubble where speculative fervor outweighed any economic fundamentals. He also discusses the genesis of the Case-Shiller housing price index and his idea for how it might be used to reduce risk in the mortgage market.
http://www.econlib.org/library/Downloads/y2008/Shillerhousing.mp3
Note: This podcast was recorded on September 5, 2008
0:36
Intro. Current crisis in housing market. Great Depression: We pulled together in many different ways. Spirit that we are going to solve this problem together will keep it from being worse. Capitalism is a wonderful invention, has to have a popular sense that we all support this and it's all for us. What's disturbing about the current crisis is the sense that some people are being ill-treated. Who are those folks? Complicated. Many crises in history don't make any sense. This one driven by a sequence of speculative bubbles, stock market bubble, interrupted in 2000, 2003; housing. What is a bubble? Usual definition: Unwarranted asset price boom, not related to fundamentals. Defined by the fact that it will burst. P. 2 of Irrational Exuberance, DSM definition, hard to define a mental illness so you list symptoms that are characteristic of that syndrome but not necessarily all present. Situation where there are a sequence of price rises for a speculative asset which generates a social epidemic, generates contagion, certain ideas that become prominent. New era stories, envy, trading successes become prominent in people's ideas, sense of your self changes for a while, become more self-confident because you think you've discovered your investing genius. Why does it end? It can't go on forever. Prices are rising because people expect them to rise further. Someone will want to sell. Idea of a bubble goes back hundreds of years.
6:07
Role of psychology, behavioral approach. Explanations are easier ex post than ex ante. At the time there are some effects that are consistent with the price rise. How do you distinguish which ones are psychological? A matter of enlightenment. If you think about bubbles as a phenomenon you will learn earlier to recognize them. People did recognize this bubble. That's what ends them. If you think you are wiser than the herd, there is a temptation to ride the rise upward, so long as you can bail out at the right time. Part of the reason why bubbles are so inscrutable. Recent real estate bubble went on for 6 years. Not going to change over night. Can get in for a short time safely. Only those left in at the end get hurt. Transactions costs of moving in and out of the housing market are much higher than the stock market.
10:13
Challenge the idea that there was a bubble. Subprime aspect: Two ways to think about the current housing market: bubble that pops, systemic effects, or that it may have had some bubbly aspects but the crisis part is in the subprime market where foreclosures play a human side to the story, securitization. Speculative boom, major historical event; multiple causes, always other factors. One other factor relevant to the recent boom, Reagan revolution, newfound respect for free markets, 1980, depository institutions deregulation and monetary control act eliminated ceilings on mortgage loans and created a possibility of a subprime industry. Before that it was a government industry because you couldn't charge a high rate. Good thing to let markets function, but there wasn't the accustomed regulation of these new lenders. As the 1990s wore on they were operating in a bubble atmosphere. At the same time, innovating, including the securitization of them. Seems like a good thing. When bad things happen in history it's difficult to point a finger of blame. Compromises. General assumption, received conventional wisdom, was that home prices can never fall; distorted into home prices are the best investment ever; everyone should get leveraged. Leverage pushed it up to a tremendous rate of profit. Infomercials at night; rang true. Idea that there could be a crash in home prices didn't sound real. Famine or another black plague. Sounded like a money machine even to rational people. Failure to think about the bubble. Appears that a lot of financial institutions were incautious, assets became risky and eventually worthless. Banks found themselves holding collateral that wasn't very good. It happens all the time in a market economy; people make mistakes, take risks they were not aware of; lose their money, lose their jobs if a firm goes bankrupt. Why is this new or a crisis? Not fundamentally new. Not associated with benefits. Economies with financial markets have more booms and busts, goes with the advantages of markets. Book: Helping financial markets work better, expanding them, not contracting them.
18:26
Fed's role: did it have a role by lowering interest rates artificially, causing housing prices to go up? From 2002-2005, the real Federal Funds rate was negative, not such expansionary policy since the 1970s which had a smaller more localized housing boom. That is a part of the story. Other countries also had real estate booms where real rates were not so low, though. Even that story can be thought of as part of the same problem: they didn't see that there was any risk in the housing market. Alan Greenspan didn't see it as taking a big risk with the economy by keeping interest rates so low. Fall in housing prices is the biggest single event. High prices or low prices? When they are going up, everyone says it's great; but they forget the fact that a lot of people can now buy houses that they couldn't previously. What's the advantage of high home prices? Want to see economic growth, so you want to see incomes outpacing house prices. Alternative story, real side: Housing price run-up was largest in areas with increases in demand, Washington, D.C. area after 9/11; expansion due to Silicon area in CA. Prices reflect real side demand effects, coupled with zoning laws, etc. James Hamilton: decrease is not largest in areas with the biggest booms but in other areas, ones troubled by the subprime problem. Employment is positively correlated with home prices in a region: Michigan decline is related to the decline in the auto industry, which didn't have such a boom. Some places like Las Vegas, Phoenix, San Diego, Miami are areas with rapid price decline and were places that had big booms. Housing boom was substantially mirrored in places that have had housing bubbles before. Boom in 1920s in Florida, and CA in the 1980s. Sourdough explanation: something in the air. Markets are driven by stories. The idea that you are going to get rich in real estate isn't plausible in Milwaukee or Toledo, OH. Celebrity areas stimulate people's imaginations. Economists loosely throw around that fundamentals are driving everything. Can throw a lot of variables into a regression and make anything fit, called data mining.
27:34
Zoning laws: invented in Germany, late 19th century, new idea. City would lay out a map of the city with zones; each zone would be zoned for a certain kind of construction. If you wanted to deviate you had to go before a zoning board beforehand. Before 1920s not possible in the United States, till a Supreme Court decision; no authority for a city government to intrude on people's free use of their land. Even before zoning laws there were effective requirements, like anti-nuisance laws, after a person already built. Perception that zoning laws have gotten stronger, but not entirely clear that it's true. Future of enforcement of zoning laws is ephemeral and hard to judge. Part of the new era story. Challenge is that there are so many factors involved.
30:36
Data collection: Case-Shiller home price index. In late 1980s, Carl "Chip" Case rediscovered a method that had been used as early as the 1920s, improved it. Repeat sales home price indices. Most prominent index was the median home price. Problem with that is that the mix of homes changes, so sometimes a lot of homes on the west side of a town are selling and other times the east side. Volatile series. Instead, created an index that focused on the same set of homes. Astonishingly smooth over time. Incredible inefficiency of the home market. Stock market goes like a random walk; housing market goes in trends for years. Partly because of transactions costs; but also because nobody sees the data. Data went back to the 1970s, was electronic, punch cards. In 2nd edition of book, wanted to get a long historical series, so found some bits and pieces before that, from 1890 to the present. Not the last word, but it's the only one. Dirty work. One of the challenges is dealing with new home construction. Trend in U.S. has been toward dramatically larger houses. Once they are in the index it's controlled for. Macro Markets, do what people do with stock price index. It changes substantially over time, new companies start, old companies fail or merge. Wanted the indices to be tradeable, to represent the value of the housing stock, like S&P 500. Value weighted.
37:16
Index allows wise people to make money and not so wise people to take risks or lose money. Why would you call this a crisis, given that most of the time the housing market has been pretty smooth? Last few years, people made mistakes. Why should we worry about this relative to any other mistakes people make in their investing behavior? What is the systemic part of it? Systemic externality that operates both through institutional and psychological channels. 2007 when magnitude became palpable, we saw securities down dramatically, domino effect. Bernanke testified when Bear Stearns went under, could cause contagion that would spread. Justified Fed action, enhanced the power of the Fed, less than disinterested spectator. How do we know that we stood on the brink of a crisis? We don't know. We do know that there have been terrible crises in history, like the Great Depression. Protections like Deposit Insurance; and like the Federal Reserve which was set up in response to 1913 crisis. What if Bernanke had said: Let's let Bear Stearns fail? Over $50 trillion; one contract offset with another. Not safe if there is a major failure with a company that is involved in so many of those contracts. Crisis when trading suddenly stops; atmosphere of pessimism develops. Plausible that Bernanke is right.
43:07
Non-transparency: What we have right now is the Fed acting in an ad hoc, discretionary way. Bernanke is a scholar of the Great Depression; he certainly wouldn't want another one. Costs of avoiding such a depression are not borne by him but by all of us. Agency problems. At a time of a boom, the Fed is reluctant to say something that might squelch the boom or talk about risks lest they be blamed. Bernanke has a sense of public service. Difficult to make distinction. What would make financial markets work more effectively? 1. Improve financial information infrastructure; 2. expand the scope of markets so that more risks are traded; 3. improve retail products. Democratize finance. Take opportunity to continue the trend. Have to extend the scope of financial functioning so that it helps more and more people. Current situation is a failure to apply the basic principles of risk management well. People were encouraged to put leveraged investments into one city; undiversified use of their life savings, depending on Social Security. Mortgages that are risk managing for the homeowner: workout continuously, not only at crisis time. Mortgage payments indexed to home prices so that when home prices go down, mortgage balance and payments would go down. New standard. In 1930s, new standard, moving from 5-year rolling balloon payment mortgage to long term 15-30 years. Could have moved further forward. 2008 Housing and Recovery Act is an after-the-fact workout. Would a bank find that attractive? Futures markets for single-family home trading at Chicago Mercantile Exchange, but not very active. Mortgage issuers would be able to hedge themselves, international marketplace, spreading the risk. Same argument used for subprime market, securitization. Core idea was not the problem; it was the implementation. Financial education. Current crisis could cause a reversal of the good trends of democratization of finance. A lot of people are able to own homes.
53:16
Would a bank find such an instrument to be profitable? Banks and insurance companies: home equity insurance could be offered separately. Get enthusiastic responses, but we don't have a liquid market for a home price derivative. In the U.K. there is a lot of commercial derivative trading. We may see more willingness once they see the hedging markets. Financial markets have shown progress in every decade of the last century. Taping on Sept. 5, 2008. Book is 178 pages, non-technical, accessible treatment. Fairness and bailouts: Congress designed a band-aid with the Housing and Recovery Act. What if nothing happens beyond that? No political solution, no further band-aid expansion. Signs of a weakening world economy, home price debacles elsewhere. If we don't do anything we might be in for a serious recession. Japan-style outcome: risk of a slow economy for some time going forward. Risk of social bad feeling that expresses itself with unrest in labor markets and less willingness of entrepreneurs to take risks. Bad outcome but not as bad as the Great Depression. In Japan, the lost decade. Could be increases in prime rates. Hard to predict. Interesting times for economists.
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment