Wednesday, November 04, 2009

# Posted 9:21 AM by Ariel David Adesnik  

THE MAN WHO PREDICTED THE FINANCIAL CRISIS, PART II: In the mid-1990's, Yale economist Robert Shiller predicted the dot-com bubble would burst. In 2005, Shiller predicted the housing bubble would burst. Why?
In the wake of the dot-com crash, which helped make Shiller a public figure, Americans turned their financial attention from stocks to real estate. House prices were rising rapidly, and people had begun to see real estate as a can't-miss investment. Shiller wanted to know what history might say about that, but he realized that data for house prices didn't exist going back more than a few decades. "Clearly," he has written, "no one was carefully evaluating the real estate market and its potential for speculative excess."...

Over the long term, house prices tend to rise at the same rate as household income. If prices increase more slowly than income for a few years, they soon catch up. If they rise more rapidly than income, they eventually come back to earth. In early 2005, Shiller published a second edition of Irrational Exuberance, which added a chart on house prices.

That summer -- which turned out to be the very peak of the housing bubble -- Shiller and [the author] had lunch in New York. He told me that day that over the coming generation, he expected inflation-adjusted house prices to decline by 40 percent. In all likelihood, he said, the bursting of the housing bubble would at some point cause a recession.
The article doesn't mention if Shiller, like John Paulson, put his money where his mouth was, betting heavily on a housing crash. Then again, Shiller is an academic, so betting his reputation is certainly worth something.

As I said below, I'm not an economist and I have no idea whether the Cassandras of the housing bubble were ignored for the wrong reasons or the right ones. But it is striking that those who warned of terrible things to come seem to have thought out their position quite systematically, and were not just venting their personal pessimism.

Cross-posted at Conventional Folly
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