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Mind Their Behavior, Real Estate Economics Is Not All About The Numbers

I am often struck by the volume of data that has been dissected, analyzed, processed and examined during the transition period that the housing market seems to be going through. Yet I often have the impression that the public is no more informed than before. Perhaps thats because we could be missing one important element: behavioral economics. Greed. [1]

In the article Lunch with the FT: The man and the bubble [FT] [2], Jim Pickard has lunch with Robert Shiller, the well-known Yale economist who wrote the book irrational exuberance and predicted the NASDAQ correction 5 years ago. Professor Shiller is someone I admire greatly, have had the pleasure of meeting and corresponding with, and have been a big fan of his work for sometime. This is what he thinks about the current state of the housing market:

Bernanke thinks there is no housing bubble,” says Shiller. “According to the White House website, he said recently that the fundamentals explained house price movements except in some speculative markets.” The new chairman of the Fed is a “brilliant man”, Shiller continues, but he has not shown any interest in behavioural economics.

And this is where he has underestimated the danger posed by real estate speculation. “He is not attuned to one of the great innovations of our time, that is, bringing psychology back into economics.

Here we come to the crux of Shiller’s theories about asset bubbles, whether tulips, shares or property: people get excited as they see the price of an asset rising, so they buy more, which pushes the prices up further until they are unsustainable. “The bubble is made by a ‘story’, by excitement and glamour,” he says. And then, once a market loses that momentum, it will experience negative feedback, where people rush to sell before things worsen further

the number crunchers have ignored the bigger picture

One striking theme within Irrational Exuberance is Shiller’s preoccupation with greed. He writes about the 60-fold rise in gambling in the US since 1962 and suggests that this new-found appetite for risk has spilled over into how people approach investment. The real estate bubble, he argues, has simply replaced the last stock market bubble as the focus of people’s avarice.

Besides, who gets to claim victory if the housing market does crash? Since the Economist magazine (which I subscribe and enjoy) has been calling the crash for about 4 years, Shiller for about that long, Bubble blogs as well as others. Who gets to lay claim to “calling it?” if something bad happens?

Shiller makes an interesting point and gambling really is everywhere [Seth Godin’s Blog] [3] – Powerball – look at the new poker craze on television – seemingly paralleling the housing boom, however, I am not sure I agree with his attempt to actually call a crash. It makes me wonder whether a component of a crash, are the influences of experts who try to call it. Sooner or later participants in the market can actually start to believe it, doubt enters the fray and…crash – classic self-fullfilling prophecy stuff.

His theory seems to assume that a run-up in values of an asset class can only end in disaster because of human nature. I think that a weakening housing market does not necessarily behave like a weakening stock market. Housing prices are sticky on the downside, yet stock values can evaporate overnight. Housing bubbles are localized and are subject to different influences in different markets whereas stocks are much more efficient.