Things that go boom...

              



Things That Go Boom
by Robert Shiller


It seems that no one in the 1990s forecast the doubling of home prices since 2000 in cities in the U.S. and many other countries. ... Books really predicting the housing boom started to appear only after it was well underway, when their forecasts were simple extrapolations. ...

We shouldn't blame these people for not seeing the boom coming. Nobody did. But those economists who say today that the real estate boom has been justified by "fundamentals" have to explain why they weren't able to forecast the high home prices we have today based on those fundamentals.

With the failure of anyone really to predict today's high home prices, one may well conclude that no one can predict ... the housing market... That may be the right conclusion...

On the other hand, there is another perspective on this colossal failure to predict. Maybe it doesn't mean that no one can forecast, but instead that the high home prices today are just an enormous anomaly that will have to correct downward sometime, if not right away.

This has been the biggest housing boom in world history, and when one looks at a long-term chart of U.S. home prices, this boom stands out among the other price increases like the highest kite in the park. It certainly looks anomalous, and maybe it is. Moreover, home-price booms, and sometimes at least real estate busts, seem awfully persistent lately, so that it looks like we should be able to forecast them. ...

Some short-run indicators have been interpreted as showing that the recent weakness in the housing market may be correcting upward. ... But the increase may be attributable in large part to unseasonably warm weather and sales incentives. ... The futures market still predicts home price declines in all traded cities over the next year, though modestly lower declines than in the recent past. ...

The fact that home prices have risen so high relative to construction costs and other indicators suggests that home prices might fall back substantially in some markets -- and maybe that is what is going on. But one can hardly be sure about whether and when it will happen. ...

We are left with a deeply uncertain situation, but one in which it would seem that a sequence of price declines continuing for many years has some substantial probability of happening. Traditional finance theory has trouble reconciling even a semi-predictable sequence of price declines with basic notions of market efficiency. The situation we are facing is a reminder of the glaring inefficiencies and incompleteness of existing markets for residential real estate, and may be regarded as evidence that institutional changes will be coming in future years to fundamentally change the nature of these markets.