Issue: 77
Sent: 01-05-2007 10:01:52
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Irrational Exuberance Revisited - 5 - Lester Wills
In the last few articles I have been reviewing the presentation given by Professor Robert Shiller of Yale University entitled 'Irrational Exuberance Revisited'. I will be continuing with that theme this time but focussing on his views on 'Trends in Real Estate.'
Shiller suggests that whilst the stock market bubble has burst, there is clear evidence that there is currently in what appears likely to be a housing bubble. Given the price hikes that have occurred in Australia over the last few years, similar assertions could be made here. However, like the UK, Australia is facing record numbers of defaults, so perhaps the bubble is starting to deflate, albeit slightly.
Shiller suggests that the concept of a housing bubble is, in an important sense, a new phenomenon. He bases this upon some analysis since 1980 where he has been counting (using electronic searches) the times the phrase "housing bubble" appeared in newspapers. He found that the phrase was not used at all before 1987. Then, it began to appear right after the stock market crash in 1987 but died out again only to suddenly reappear in 2002.
Shiller argues that the US has entered a speculative phase with many people thinking it is a housing bubble (with similar arguments in Perth at the moment). He suggests that many people are buying real estate today because they think real estate prices will go up for a while. As he points out, such mentality, propels the bubble for a while.
He also suggests that nontraditional mortgages have helped fuel the housing boom. There has also been a deterioration in lending standards and a proliferation of adjustable-rate mortgages (what we would call floating rate mortgages). He argues that people with very small down payments are buying houses, and too many of them are considered lower income or have poor credit histories.
On that note, is it just me are there an incredibly large numbers of adverts around at the moment telling people how they can get loans from all sorts of places, even if the "banks" have turned them down? I seem to recall one suggesting consolidation and adding new loans for cars, holidays etc. and putting it all into a housing mortgage. The sheer number of such adverts let alone what they are suggesting starts alarm bells ringing in my head But there again, I could just be missing something.
Back to Shiller.
Shiller decided to examine the pricing a standard home and looked at every price index for homes to try to get a quality control price index. Because no long-term historical time series exists for home prices, Shiller created one. However, he adds the caveat that it is not constant over time as homes have gradually gotten bigger during the last 100 years or so. Not only that, whilst he was able to locate a number of series to use, he had to fill in gaps to create his index.
Interestingly he found that starting in 1890, home prices in real terms did not grow much until 1997, when they started shooting up and showing all the signs of a bubble. Back in the 1950s, economists reasoned that home prices were driven by building costs. They found that the change in real home prices very roughly mirrored the change in building costs. But that relationship appeared to break down as currently no correlation exists between the two.
Furthermore, the jump in home prices cannot be explained by population increases because the population has been growing steadily, with no sudden jump after 1997.
Finally, interest rates cannot explain the sudden increase in home prices after 1997 because interest rates have been on a rather steady decline since the early 1980s, with no sudden move down after 1997.
As a result Shiller believes that the increase is psychological. He argues that home prices have not gone up in real terms over long periods of time. Thus, a house has not been a great investment, unless, of course, one has a sufficiently high valuation of the "dividends" the house pays in terms of housing services.
More next time, including some extremely surprising information about housing producing long-term returns of less than 1% per annum.
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