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Shiller on the Housing Bubble

Posted By Barry Ritholtz On June 19, 2005 @ 7:17 am In Real Estate | Comments Disabled

Before we can discuss Real Estate, I want to address the somewhat internally conflicted position I have staked out on the Housing Bubble: 

First, with full contrarian glee, I have been saying that it is an extended asset class, and not a full blown bubble [1] — at least not yet. At the same time, I have made no bones about what I see as an increasing possibility that the market tops out towards the end of this year, and that 2006 is potentially no fun for the long only crowd [2].

Housing may play into this process, but in a way I have yet to fully determine. Will a big equity market drop chase people out of stocks and into realty, eventually superheating it? Will interest rates trip up Home prices, forcing the interest-only-idiots to liquidate other assets, and thereby spill into equities, causing a crash? 

I do not know, but I find imagining the various scenarios intriguing. Meanwhile, like any good strategist, I am warily reading perspectives from smart people, and watching the different datapoints which may ultimately lead to this sector’s denouement (which seems to have become my new favorite word [3]).

Which leads us to a Barron’s [4] interview [5] with Yale Economist Robert Shiller [6]. Note that his book, Irrational Exuberance [7] was a perfectly timed discussion about the biggest bubble ever [8].   

Let’s start with this chart:

The Key Trends Impacting Housing:
click for larger chart 
Barrons_shiller_206172005223742 [9]
chart courtesy of Barron’s [5]


A few thoughts about this chart: We know that the most important factor impacting R/E prices are interest rates — yet this 115 year chart hardly shows the significance of rates at half century lows. At what point does yield pass a tipping point [10] that generates a significant cycle upwards in real estate prices?  Further, let me also remind you that home ownership did not become a middle class  "birthright" until after WWII. So the 3.42% yield of 10 year in 1890 is rather irrelevant to the present discussion. Indeed, the entire scale of the chart seems designed  to make the recent price spike even more frenzied.

Still, that chart looks ominous. If it were a stock, I would
suggest that the vertical red line (Home Price Index) looks like Iomega
or Qualcomm did as their huge run ups ended, and the stocks
peaked and tumbled. However, this is not a stock chart — its real estate. Perhaps they work the same, maybe they don’t. Quite frankly, I have no means to tell if the two asset classes exhibit the same visual technical warning signs.

Why? Over the years, I’ve reviewed 10s of 1,000 of stock charts. (I’m sure many of you have also). I have developed a good feel for when something has gone vertical, and is about to keel over. I assume many readers have similar experiences.

But you and I have no experience whatsoever reading Real Estate charts. The chart above could be enormously significant — or it could be a graphic depiction of assets with no predictive power whatsoever. I DO NOT KNOW. Do we know if technical charting works for R/E?  Because an R/E chart looks like a dangerous equity chart about to top out, can we assume that it is the identical situation? Again, I (and I asusme you also) simply do not have enough experience looking at Real Estate graphs to hazard a guess. 

All that said, Barron’s takeaway from the always interesting Robert Shiller is worth a read:

"The Yale economist has done much work over the years on the behavior and psychology of the residential real-estate market, including a number of annual surveys of current expectations of homeowners around the U.S.

In 1988, dissatisfied with the home-price data put out by both the National Association of Realtors and the federal government, he and Wellesley College economist Karl Case established a price index based on "repeat sales" (to filter out distortions from changing mixes of house sales or other problematic factors). The project led to the formation of a company called Case Shiller Weiss that later became part of Fiserv. The CSW survey captures reliable housing data from major markets throughout the U.S. that tends to closely track the best price data put out by the U.S. Office of Housing Enterprise Oversight.

Shiller’s data show a housing bubble of extraordinary dimension.

The rise in real prices since 1997 has already dwarfed the surge after World War II, when long-pent-up demand for homes overwhelmed supply for a time. And it only seems to be gathering velocity, with each year’s increase topping the previous one’s. Though in 1997 real U.S. home prices went up 2.1%, by 2000 the rate of increase had accelerated to 5.8%. Last year it hit a torrid 11.2%, and Shiller believes it exceeded 15% in this year’s first quarter. The housing-price chart has gone nearly vertical, in seeming defiance of the gravitational drag of inflation and more subdued growth in personal income and gross domestic product.

As a market behavioralist, Shiller takes a dim view of what he calls the glib fundamental explanations offered by the housing bulls to justify home prices’ moonshot."

What I admire about Shiller is the way he theorizes explanations for various phenomena:

To Shiller, the housing bubble grew out of the same irrational exuberance that gave rise to the 1995-2000 stock mania. That would perhaps explain why most of the housing bubbles around the globe occurred in countries that also had stock bubbles. A recent study by the Bank of International Settlements of home prices in 13 industrialized countries indicated that peaks in home prices tend to trail stock-market peaks by two years or so.

I have discussed the 2 year delay following a market top off line — the 1987 crash saw NY Real Estate peaking by 1990 — but the reason is obvious: After the end of a business cycle and/or market crash, Central Banks (here as well as elsewhere) start cutting interest rates. That leads to home price appreciation.

Here’s another interesting thought:

"Shiller theorizes that both U.S. bubbles were precipitated by such factors as increasing veneration of market capitalism, the growing respectability of speculation and conspicuous consumption, and the conviction that the Internet and other technologies augured a golden age of unparalleled prosperity. Notes Shiller dryly: "Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors."

Quite fascinating stuff . . .

The Bubble’s New Home [5]
Barron’s June 20, 2005      

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/06/shiller-on-the-housing-bubble/

URLs in this post:

[1] extended asset class, and not a full blown bubble: http://biz.yahoo.com/ts/050526/10225437.html?.v=3

[2] no fun for the long only crowd: http://www.smartmoney.com/theproshop/index.cfm?story=20050602

[3] my new favorite word: http://www.google.com/search?num=50&hl=en&lr=&c2coff=1&q=site%3Abigpicture.typepad.com+denouement&btnG=Search

[4] Barron’s: http://online.barrons.com/

[5] interview: http://online.barrons.com/article/SB111905372884363176.html

[6] Robert Shiller: http://www.econ.yale.edu/~shiller/

[7] Irrational Exuberance: http://www.amazon.com/exec/obidos/ASIN/0691123357/thebigpictu09-20

[8] biggest bubble ever: http://www.thestreet.com/funds/investing/915986.html

[9] Image: http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/barrons_shiller_206172005223742.gif

[10] tipping point: http://www.amazon.com/exec/obidos/ASIN/0316346624/thebigpictu09-20

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