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Crooked Timber's Brain Explodes

Robert Shiller: U.S. Coastal Property Markets Are Overvalued

The Financial Times has lunch with Robert Shiller:

FT.com / Arts & Weekend - Lunch with the FT: The man and the bubble By Jim Pickard: The Yale professor correctly predicted the last stock market crash five years ago in his book, Irrational Exuberance. Now he is predicting a property meltdown.... for a 59-year-old - young features. He wears a blue jacket over a light blue shirt.... Shiller has sold truckloads of books by using plain English and eschewing more arcane economic theory. But he is not averse to more complicated words....

What I really want to know, not least as a homeowner, is when and how the property market will crash. So I ask him. For a man whose written predictions seem so definite - and dire - he appears loath to be nailed as an inveterate doomster. “I really don’t know what prices will do,” he says hesitantly, playing with his cutlery. But hasn’t he predicted a huge drop in US house prices? Only in some specific cities and states, he clarifies. The professor is no doubt aware that the history of economic forecasting is littered with the names of those who made the right forecasts at the wrong time.

He was already well respected before he became an author. Indeed, he may have been the one who lent Alan Greenspan the phrase “irrational exuberance.”... Shiller’s life has changed since Irrational Exuberance was published in 2000. He now gives a dozen speeches a year to business audiences across the world and makes frequent media appearances....

Alan Greenspan was praised for his handling of the economy during his interminable run as head of the Fed; in particular for his rapid cuts in interest rates to keep the economy afloat after the last stock market crash. Yet this has pumped up the housing bubble even more. I want to provoke mild-mannered Shiller into a little criticism. What, exactly, can Ben Bernanke, Greenspan’s successor, do to rescue the US economy if the property market crashes? Has the Fed already used up its one silver bullet - that of interest rate cuts?

“Bernanke thinks there is no housing bubble,” says Shiller. “According to the White House website, he said recently that the fundamentals explained house price movements except in some speculative markets.” The new chairman of the Fed is a “brilliant man”, Shiller continues, but he has not shown any interest in behavioural economics.... Here we come to the crux of Shiller’s theories about asset bubbles, whether tulips, shares or property: people get excited as they see the price of an asset rising, so they buy more, which pushes the prices up further until they are unsustainable. “The bubble is made by a ‘story’, by excitement and glamour,” he says. And then, once a market loses that momentum, it will experience negative feedback, where people rush to sell before things worsen further....

First, I ask, is he underestimating the role of low interest rates in fuelling the global property bubble? Prices may seem ridiculously high but if the cost of servicing property debt is low, why should it matter? Shiller’s reply seems well-rehearsed: interest rates are not so low in a historical context and in the US they are rising. An unprecedented number of variable rate mortgages... spells danger.... My second criticism is that it is not enough for an academic to point out when a market has over-heated. It’s only really useful to know when a market is so over-heated it will implode. In other words: timing. It is a point that he concedes....

Later, as Shiller eats a poached pear with cinnamon ice cream - which he declares delicious - we discuss his own investment approach. If the professor thinks that property and shares are both overheated, then where would he invest? Under a bed in cardboard boxes? Shiller’s advice is to diversify and to keep plenty of money in the bank or in “boring” inflation-proofed bonds....

Launceston Place Restaurant, Kensington, W8, London

1 x cauliflower soup with blue cheese croutons
1 x pan-fried black pudding with apple sauce
2 x roast cod with parsnip puree and curry cream
1 x poached pear with cinnamon
1 x coffee
1 x bottle mineral water
1 x cranberry and apple juice
Total: £52.75