One of my economics heroes, Robert Shiller whose work I have admired (but not always agreed with) wrote a provocative commentary on “Booms” in the Wall Street Journal last week called, interestingly enough: Things That Go Boom [WSJ].
We shouldn’t blame these people for not seeing the boom coming. Nobody did. But those economists who say today that the real estate boom has been justified by “fundamentals” have to explain why they weren’t able to forecast the high home prices we have today based on those fundamentals.
With the failure of anyone really to predict today’s high home prices, one may well conclude that no one can predict today whether a home-price bust is coming, or whether the housing market will land softly, or even is poised to resume its upward climb. That may be the right conclusion about our ability to forecast the markets.
On the other hand, there is another perspective on this colossal failure to predict. Maybe it doesn’t mean that no one can forecast, but instead that the high home prices today are just an enormous anomaly that will have to correct downward sometime, if not right away.
Basically, the premise in his piece is the idea that fundamentals didn’t help us predict the housing boom to the extent that it occurred, which means that fundamentals can’t tell us whether we will have a hard or soft landing either.
Can anyone define what housing fundamentals actually are? The term is always used rather loosely and infers strenuous economic consideration. How about: Employment? Housing Starts? Inventory? Mortgage Rates? GDP? Its seems to me that the list is subject to debate, and the assumption that fundamentals are solid is based on a list that is not universally agreed as fundamental.
Professor Shiller was the creator of the housing index used as the basis for trading on the Chicago Mercantile Exchange last May, which has been characterized as garnering very little interest by investors.
Perhaps the lackluster interest is because it doesn’t include all elements of the housing market including new home sales (a significant factor) and foreclosures (a rising factor). The index predicts price declines in 10 major markets that are currently being covered but it seems like the same sort of experience (in reverse) made by individual investors who could do no wrong in the late 1990’s because every stock was going up.
I lost interest in following the CME price patterns because of the low trading volume. The volume in specific markets seems to be more of the story these days than the reliability of the pricing.
We are left with a deeply uncertain situation, but one in which it would seem that a sequence of price declines continuing for many years has some substantial probability of happening. Traditional finance theory has trouble reconciling even a semi-predictable sequence of price declines with basic notions of market efficiency. The situation we are facing is a reminder of the glaring inefficiencies and incompleteness of existing markets for residential real estate, and may be regarded as evidence that institutional changes will be coming in future years to fundamentally change the nature of these markets.
It doesn’t seem like anyone has a handle of the direction of macro real estate markets at the moment, beyond relying on conventional wisdom. Professor Shiller seems to be moving away, if just a little, from the position that indexes can be used to accurately predict real estate markets, despite his groundbreaking work in this area. He seems to be moving toward the conventional wisdom argument what comes up must come down.
Tags: Robert Shiller