Nobel prize winning economist Robert Shiller recently revisited the Housing Bubble in an article published in the New York Times (“How Tales of ‘Flippers’ Led to a Housing Bubble,” May 18, 2017). He is troubled by the lack of consensus on what caused the bubble-bust that left the world mired in the financial crisis. He states: “We need to understand it all if we are going to be able to avoid ordeals like that in the future.”
Shiller argues that the wild ride in housing prices from 1997 to the present cannot be explained by the conventional data that impacts real estate, such as interest rates, construction costs, and rental rates.
He argues that the phrase “housing bubble” was not even in use until 2005, the peak of the bubble. Instead he notes that the typical narrative for housing was all about smart investors making money. In particular, he focuses on flipping houses which changes the narrative to: anyone can get rich without much knowledge, talent, or effort. While this explanation sounds silly, it is worth noting that the top officers of the Fed were actively and deceptively cheerleading markets all throughout 2007 as I show here.
Shiller suggest that such flipping is part of an unregulated process “that constitute the shifting mentality of the era.” In other words, he believes psychological factors, rather than economic factors, are the cause of these problems. He concludes that the Dodd-Frank financial regulation is necessary to quell these unsubstantiated psychological urges that can cause financial chaos in the economy. Furthermore, he suggests that Trump-inspired deregulation will cause the chaos to quickly return.
Was the housing bubble really a secret before it busted? I wrote about the bubble as early as February of 2004, identifying its beginning in 1997. I wrote about it again in June of 2004 and it was a popular discussion and lecturing topic throughout the whole period. I even wrote about the impending bursting of the bubble in the fall of 2005! Others wrote about a housing bubble in 2003, including Frank Shostak and Christopher Mayer. Robert Blumen and Sean Corrigan were writing about it in 2002!
Shiller argues that the housing bubble cannot be explained with conventional data that is thought to influence real estate. This assertion is completely untrue as I explain in my 2006 essay “The Economics of Housing Bubbles” (which was published in 2009).1 The Federal Funds rate and the interest rate on 30-year mortgages were at historically low levels. Real estate loans from commercial banks more than doubled between 1997 and 2006. Investment spending on residential real estate increased by over 50% over this same period. A string of all time records in housing starts began in 2003.
Shiller is also wrong with his psychological explanation for the housing bubble. Psychological explanations are a comfortable resort for those who work with a flawed economic theory. But a change in market psychology is an effect, not a cause. Can you imagine a full blown economic bubble without a positive psychological change in terms of enthusiasm, risk taking, etc.? Austrian economists expect such effects on market psychology after artificially low interest rates increase profits and asset prices across the economy.
Shiller sees no current bubble due to Dodd-Frank, but expects one if it is repealed. From my vantage point, I see the Fed and other central banks creating many bubbles, including housing and real estate. In other words, Robert Shiller is wrong on all the points he makes in his article.
I am often asked the question: “are mainstream economists stupid, or are they liars?” My response is that many are intelligent, honest, and seemingly public spirited, but they are slaves to a bad understanding of how an economy works and they live in an environment where bad economic ideas are highly rewarded. In particular, ideas that support the State are highly compensated in terms of money and prestige. They also often suffer from the pernicious ideology of progressivism.
I recently reviewed the new book by Shiller and Nobel award winning economist George Akerlof, Phishing for Phools: The Economics of Manipulation and Deception. I have never read a more personally biased, uninformed, and just plain wrong book on economics. Their basic approach is based on the notion that the competitive pursuit of profits leads entrepreneurs to discover deceptive ways of “phooling” customers and this manipulation will continue until some public-spirited bureaucrat comes in to break this “equilibrium” with new and stronger regulations.
It would seem that Akerlof and Shiller have been locked in their ivory tower without access to the internet for the last 20 years. Are they not aware of Consumer Reports, Underwriters Laboratory, Angie’s List, consumer reviews on Amazon.com to name a few things that protect consumers, not to mention competition? My conclusion: “This book promotes a view of the free market that is incompatible with the facts. The authors’ view of government intervention, at least until recently, was unabashedly naïve. It all seems to hearken back to Thorstein Veblen and John Kenneth Galbraith and other institutionalist economists who substitute personal value judgments for economic theory.” In other words, they provide the rationale for more extensive state intervention in the economy.
The lesson here is that a bad economic framework will almost always result in bad economic analysis and that a good economic framework is essential for enlightening experience.
- 1Mark Thornton, “The Economics of Housing Bubbles,” in Randall Holcombe and Benjamin Powell, eds., Housing America: Building Out of a Crisis” (New Brunswick, NJ: Transactions Publishers, 2009).
