2007 November 24 Saturday
Robert Shiller Sees Long Bear Housing Market

Yale economist Robert Shiller, who along with Wellesley College economist Karl Case created a widely respected housing price index, thinks the housing price decline could go on for years.

"Guess what?" said Robert Shiller in an exclusive Reuters interview. "For those of you who thought house prices would find their bottom in 2008 - think again."

According to the Yale economist and co-developer of the S&P/Case-Shiller Home Price Indices, "The bottom is hard to predict. I do not see it imminent and it could be five or 10 years too."

"The housing situation that we got in is unique in history because there was an investor psychology that developed that was stronger than we have ever seen before," Shiller said. "We have seen housing bubbles many times in history, but they have been much more local than this one."

In the United States retiring baby boomers might sell their bigger houses and help depress prices.

"Perhaps we have gotten a little too confident in the global economic growth"

Robert Shiller, professor of Economics, Yale University, in his speech warned that possible speculative bubbles in stock, real estate and oil markets could cause instability in the global economy.

"Perhaps we have gotten a little too confident in the global economic growth. The problem is high oil, stock and real estate prices. There is a question about whether all this can be explained by low interest rates. This is a question that I can't authoritatively answer. But I believe that a substantial part is speculative bubble thinking. We have gotten too confident of the prices in these markets. The unwinding of these markets is the most serious risk facing these markets today," he said.

I worry that China will get hit by a depression due to inefficient capital markets misallocating capital on an enormous scale. Such a depression could pull the United States down with it.

Shiller thinks the various market bubbles could drive the world into a recession.

UAE. The world economy could be heading for a hard landing. This was the warming of Robert Shiller, the Stanley B Resor Professor of Economics at Yale University, in his keynote address during the opening session of the DIFC Economic Forum on Saturday 17 November 2007.

Shiller based his warning based on recent trends in oil prices and the US and international stock and real estate markets. Each of these areas, according to him, reveals speculative pressures indicating financial bubbles. If the pressures and instability continue to build, the global economy could enter another major recession.

But I think he's wrong to paint the price of oil as the result of an economic bubble. Unfortunately, the current price of oil is driven by fundamentals. Rising demand is not getting met by rising supply. Likely future oil production (PDF format) looks like another reason to be bearish on housing prices.

But if you are a renter who can manage to stay employed then bargains might be coming your way.

Really smart money guy Bill Gross sees a really big problem with the real estate debt crisis.

"We haven't faced a downturn like this since the Depression," said Bill Gross, chief investment officer of PIMCO, the world's biggest bond fund. He's not suggesting anything like those terrible times — but, as an expert on the global credit crisis, he speaks with authority.

"Its effect on consumption, its effect on future lending attitudes, could bring us close to the zero line in terms of economic growth," he said. "It does keep me up at night."

This article by AP writer Joe Bel Bruno has a lot of excellent data on the state of the US real estate market and of consumer indebtedness. Look for 3 million jobs to go bye bye, more than in the last recession.

Based on historical models, zero growth in the U.S. gross domestic product would take the current unemployment rate to 6.4 percent. That would wipe out about 3 million jobs from the economy, according to the Washington-based Economic Policy Institute.

By comparison, in the last big downturn between 2001-03 some 2 million jobs were lost, according to the Labor Department.

The huge flood of adjustable rate mortgage rate resets coming up in 2008 and 2009 will push up lots of interest rates from teaser rates to 11% and 12%. Lots of people will be faced with near doublings of monthly mortgage payments and they won't be able to make them. The Collaterized Debt Obligations (CDOs) which mortgages have been bundled into create situations where there's no single creditor with a consolidated interest in rate negotiation. The mortgages have had their interest payments separated off and sold separately from their principle repayments. The securities have been sliced up in other ways with different tiers of creditors with highly conflicting interests that make many mortgages hard to impossible to renegotiate. The rocket scientists on Wall Street have created a lot of rockets that are going to explode.

Though some do not think the ARM resets make the problem much bigger.

Still, Christopher Cagan, the author of the First American study, isn't so alarmed.

The ARM resets will cost an extra $42 billion a year, roughly 0.4% of the nation's gross domestic product he estimates. (Adding some context, he notes that Americans spend much more than $100 billion a year on booze.)

I think 3 big macroeconomic developments are about to collide: 1) The housing market debt and price meltdown; 2) The retirement of the baby boomers; and 3) Peak Oil. Whoever wins the 2008 US Presidential election is going to find it a very hollow victory. Many of the rest of us won't find it much fun either.

Update: Robert Shiller argues in a New York Times piece that housing prices might decline as much as 30%.

WE have to consider the possibility that the housing price downturn will eventually be as big as that of the last truly big decline, from 1925 to 1933, when prices fell by a total of 30 percent.

He argues for a number of regulatory and legal changes to reduce the risks and costs of big housing market failures.

Congress is already on track to eliminate the provision — Section 1322 of Chapter 13 of the bankruptcy law — that prohibits courts from adjusting terms of first mortgages. But there could be more fundamental changes to bankruptcy law than that.

Bankruptcy law is a risk management institution, and such an institution should adopt more modern practices. For example, Andrew Caplin, professor of economics at New York University, has proposed that in personal bankruptcy proceedings, the courts should be allowed the latitude to substitute real estate equity — a share in the ownership of the property, to be realized when it is eventually sold — for first mortgage debt. This could let troubled borrowers stay in their homes, and might be better in terms of efficient risk sharing: it would provide incentives for the mortgage industry and would be friendlier to prospective home buyers who would otherwise face higher mortgage rates to pay for others’ bankruptcies.

I don't see how this measure would reduce the interest rates for prospective buyers. The modified mortgages would still end up being a loss to the creditors. Also, giving real estate equity to creditors would be extremely problematic. Someone might not sell for decades. When they do sell they will be less incentivized to maximize sales price since less of the proceeds would go to the seller. Creditors would face legal liabilities as part owners that they would not otherwise face.

Shiller also argues for home equity insurance. Well, he ought to take a hard look at the bond insurance companies that are currently on the verge of bankruptcy because they never expected so many collateralized debt obligation (CDO) bonds to greatly decline in value. Risk can't be reduced unless incentives for risky behavior are reduced. That's where we need changes.

Share |      By Randall Parker at 2007 November 24 02:25 PM  Economics Housing


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