Q&A with Robert Shiller

This leading Yale economist, perhaps best known for the home-price index that bears his name, offers his views on real estate market behavior and what’s holding back the housing recovery.


Mortgage Banking

September 2011


By Robert Stowe England


Robert J. Shiller is the Arthur M. Okun professor of economics at Yale University, New Haven, Connecticut. He has written on financial markets, financial innovation, behavioral economics, macroeconomics, real estate and statistical methods, and on public attitudes, opinions and moral judgments regarding markets.


Shiller’s repeat-sales home-price indexes, developed originally with Karl E. Case, professor emeritus of economics at Wellesley College, Wellesley, Massachusetts and a senior fellow at Harvard University’s Joint Center for Housing Studies, Cambridge, Massachusetts, are now published as the Standard & Poor’s (S&P)/Case-Shiller Home Price Indexes. The Chicago Mercantile Exchange now maintains futures markets based on these indexes. The monthly index is regularly headlined in the financial press.


Shiller has produced an impressive volume of distinguished research. His book Irrational Exuberance, published in 2000, is an analysis and explication of speculative bubbles, with special reference to the stock market and real estate. The New Financial Order: Risk in the 21st Century, published in 2003, is an analysis of an expanding role of finance, insurance and public finance in our future.


Shiller’s most recent book, published in 2008, is The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It, and it offers an analysis of the most recent housing and economic crisis.


The Yale professor, alternating with Howard Davies, deputy governor of the Bank of England, writes one series of the regular column, “Finance in the 21st Century,” for Project Syndicate, which publishes around the world, and contributes to “Economic View” for The New York Times.


Mortgage Banking caught up with him recently at his office at Yale University.


Q: Based on your index of American home prices going back to 1980, where are we now in terms of moving lower to earlier price levels? Are we back to 2002 home-price levels?


A: It’s hard to be precise about these things. Looking at the plot, it looks like we’re almost back to [the] average level for the century from 1890 to 1990 [see Figure 1]. People would have imagined that there was an uptrend in that period. But in fact, there wasn’t. There was virtually no change in real inflation-corrected home prices between 1890 and 1990. And so I think it’s meaningful to talk about the level--but only roughly, because we don’t measure these things accurately.


But the thing is, that over the century, from 1890 to 1990, land was, of course, getting more scarce. So you might think that home prices would rise in real terms. But offsetting that were improvements in the technology of building homes. And actually, the percentage of home value that is accounted for by land is small--maybe 20 percent. So it just kind of canceled out and there was no change.


It looks like we are almost back there [to the average real price for the century]. We are still high, but it’s something like 20 percent, 10 percent. I have been quoted a lot for saying that home prices might fall another 10 [percent] to 25 percent. That was just a guess of what might happen. But it’s based on this chart (Figure 1). Actually, I said that in February 2011--I was referring to a decline from the first quarter of 2010.


That [degree of potential decline in home prices is] the kind of fall that would get us back to where we were for 100 years.


Q: So that didn’t include the decline that has occurred this year?


A: Our national index went down 4 percent in the first quarter. I don’t know what home prices are going to do. As I said then, in real terms, they might well decline further. I just don’t have any way of knowing. And if you look at this chart, it wouldn’t be outlandish to see it fall from fourth quarter of [2010] by 10 [percent] to 25 percent in real terms. I just don’t know what it will do.


Q: Could it go lower than the trend line--that’s what you see in Figure 1 for the period of the 1920s and 1930s?


A: If you look at the down trend from 1890 to 1940, that’s 50 years--that’s kind of a general down trend. And if you look at what economists said about that, it was common to attribute that to progress. Things get cheaper. Now, houses are being built bigger. If you go back to 1890, people lived in much smaller, cramped quarters than we do now. These price data abstract from that.


Q: With prices staying level over the years, adjusted for inflation, people are getting a much bigger house for about the same inflation-adjusted price.


A: That’s right. And young people get their own house instead of staying in their parents’ house. Lots of single people used to live in rooming houses. They used to have women’s rooming houses and [there were separate rooming houses] for the men. People used to take up rooms in other people’s houses. We’re just so much wealthier now. We don’t have to do that.


Q: So, the 10 percent to 25 percent price decline is from the level at the end of 2010?


A: Right. Not from right now. But [the method of relying on historic inflation-adjusted data as a method of estimating the trend of future prices] is not that precise anyway.


Q: If prices do move lower, based on a return to the average for the century--and it’s only a possibility--no one can talk about a timeline at this point for when house prices will bottom, given that it is a rough measure


A: That’s right. I don’t think we can accurately predict, because we’ve just been through the biggest bubble in U.S. history for the nation as a whole. So we only have one observation. So how do we use historical data to do a statistical analysis?


Q: There is nothing we can look to in historical data that would give us any indication where we might go from here?


A: There are prior booms that were smaller. There was the boom of the 1980s, which was more concentrated on the coasts--in California and in the Northeast--which fizzled around 1990. And you can see that home prices didn’t start really turning up until the late 1990s.


Q: So a long period of decline in home prices might be one outcome we could face?


A: Could be. It’s very hard to predict these things, because they depend on so many things. They depend on the world economy. They depend on politics. They depend on what Congress does with Fannie [Mae] and Freddie [Mac] and FHA [the Federal Housing Administration], and with the mortgage interest deduction. And it depends on cultural values. There might be a shift toward wanting to live in the center city. That would mean new construction in the center city, if that happens, and a decline in values outside.


Q: There are those trends in place in some cities now around the country. In Washington, D.C., there has been a slow, steady trend toward wanting to live in Washington. It’s leading to an upgrade of housing stock and prices.


A: I think Washington, D.C., is about the strongest city in the country in terms of real estate values.


Q: What are you worried about most when you survey the prospects for the housing market?


A: Well, I’m worried about a systemic reaction; that is, that home prices fall, it throws balance sheets off, both of individuals and institutions, and so they stop spending. We’re seeing signs of it. That worries me a lot right now because the unemployment rate [was] creeping up in [April, May and June]. We have to see if that continues. But it does seem that the fact that home values have gone down is a factor in reducing consumption spending. That could then feed back into lower home prices. This is what happens. It could be a downward spiral.


Q: Household debt to income has fallen from 133 percent in 2007 to 110 percent recently. It still has to go a long way to be where it stood a decade ago. Is that a factor in consumer spending?


A: The decline in debt is probably because they can’t get [credit] as freely as they used to. And home-equity loans are not as available.


Q: Do you think negative equity has been a major culprit holding back the housing recovery? Has that prevented move-up buyers from being active players in the market?


A: Yes, that’s a factor. It also inhibits the whole economy because people find it more difficult to move to take a new job. So they stay put. They may be unemployed and do nothing.


Q: What about the role of consumer confidence?


A: This is an important topic. I’ve been doing questionnaire surveys of homebuyers to try to understand their confidence. And this is joint work with Karl Case, my friend on the Case-Shiller index.


The interesting thing is that homeowner confidence seems to move slowly. It has long trends. But that actually parallels something that you see with [The Conference Board’s Consumer Confidence Index®], which has been declining for 10 years now, more or less. So homebuyer confidence seemed to peak around the peak of the market, around 2006.


So one indicator that Case and I developed is that we ask people what they think the rate of home-price increase per year each year will be for the next 10 years in [their] area. And the median answer in 2005 was 7 percent a year. With our latest number [for] 2011, it’s down to 3 percent a year. So it used to be comfortably above the mortgage rate, the median expectation, 7 percent, was higher than the mortgage rate around 2005, something like 6 or 6.5 percent. And now the expectation is below the mortgage rate--3 percent expected increase [in home prices, with a] mortgage rate of 4.5 percent or thereabouts.


It used to be that leverage was on your side. And now it’s against you. And that’s an important observation to make to understand why people are not so enthusiastic about buying houses.


Q: They don’t see that much appreciation ahead of them if they are considering buying a house, and it’s costing them more than the expected appreciation in borrowing costs.


A: Back in the boom years, people were discovering leverage and thinking it was a money machine. Well, it is a money machine as long as prices keep going up faster than your interest is taking it away. They were actually doing that. And then there was the curious idea, which I found puzzling all along--that is that home prices can never fall. You know that isn’t that strange an idea if you look at the data. If you look at nominal home prices, they hardly ever fell over the last century. I’m looking at a plot of real home prices. Most people don’t think in real terms. They think in nominal terms. They fell in the Great Depression and they fell since 2006.


Some people took great confidence in [the fact that home prices had not fallen since the Great Depression]. It was almost that you would be shamed out of bringing it up. I remember [trying] to bring up the possibility that home prices might fall a lot, then people would say, “Well they never fall--or at least not since the Great Depression. You’re not bringing that up, are you? Are you saying we could have another Great Depression?”


And so you kind of back down. Of course, we could have another Great Depression. We didn’t, of course. But we did have a depression in housing prices.


There was a framing that developed that made it seem just impossible for home prices to fall, and so it looked like [housing was a money machine. You should get suspicious if there is a money machine available to everybody. You have to ask where is this wealth coming from? But most people don’t think like economists. They didn’t think it through.


Q: They get caught up in the bubble mentality.


A: This applies both to mortgage lenders and homeowners. Mortgage lenders--many or most of them--had the same view. They didn’t feel that they were doing anything wrong when they gave 95 percent or 100 percent loan-to-value [LTV ratio] on mortgages. They thought they were doing people a big favor.


Q: Back in 2000, when 100 percent lending became a big force, among lenders there was the common view that prices could not go down.


A: This is an issue of what psychologists call groupthink. Everyone is saying something. When it looks a little bit unpatriotic and [as though you are being] a prophet of doom to say otherwise, [then] it just doesn’t get said very much.



Q: What will happen to housing prices if the overall economy experiences a double-dip? Do you think that’s a possibility?


A: It depends on what you mean by a double-dip. One definition is two recessions that are so closely spaced there is hardly any gap between them. By that definition, there is only one double-dip in the post-war period. That’s the 1980 recession followed by the 1981-1982 recession. They were only about a year apart. But we’ve already gone through two years since the end of the last recession. So by that definition, it can’t be a double-dip. I think a better definition of double-dip, which I like to use . . . is a second recession that follows not necessarily immediately after the previous recession, but before the economy is restored.


The thing is that if you look at the unemployment rate, it is quite remarkable in the post-war period; it has always come down to a quite normal level between two pairs of recessions. So my definition is different. The most salient pair of double-dips would be the recession of 1929-1933 followed by the recession of 1937-1938. So the beginning of the second recession was four years after the end of the previous one. But the unemployment [rate] was, I think, 12 percent in 1937--so the economy never healed between the two. And that’s the kind of thing I’m worried about it.


We have seen unemployment tip up four-tenths of a percentage point. The concern is that it might go up more, and we’ll call that a double-dip. It only got down to 8.8 percent [in March 2011].


Q: Unemployment could then rise above the previous recent peak?


A: Right. We have other measurements of unemployment--that’s U6, which the [Bureau of Labor Statistics] computes, which is a broader measure of unemployment. There’s [also a measure I follow, which is] long-term unemployment--over 26 weeks. And that is really at record highs, even two years after the recession. It’s worse than it got in any recession. [The] long-term unemployment [rate] was 4.03 percent in May 2011--that is way above anything it ever got [to] in any recession since 1948.


Even in what was once called the Great Recession, in 1981-1982, the long-term unemployment rate only got up to 2.6 percent. So it’s troubling.


Q: So we’re a long way from full recovery, when you measure unemployment. What factors would push us into a double-dip?


A: I can sort of see [a double-dip] playing out [as a possibility.] Public confidence is dropping. There was lot of hope when Obama was elected [president] and Congress passed the [stimulus bill of 2009] with a homebuyer tax credit. I don’t know if it’s just because of [the stimulus bill] or from other factors that started to look good. But as time goes by and we see the unemployment problem not being solved, people start to become pessimistic again. This is what happened in the Great Depression--exactly what happened. And then they start calling for fiscal austerity, and that’s where we are now. And that doesn’t encourage any optimism. I can see fiscal austerity pulling the economy back and another recession [resulting].


Q: Looking at specific troubled markets--Miami; Orlando [Florida]; Las Vegas; Phoenix; and the Inland Empire in California--what is your best- and worst-case time frames and price targets?


A: There are a lot of different areas here and I don’t know that I have price targets. The thing that comes to mind is that some of these were very speculative markets. Las Vegas is an interesting case. My student [researcher] found that in some ZIP codes, [homes] were mostly bought by investors as second homes.


Chris Mayer, [professor of real estate] at Columbia University [New York], has done research on cities where there was a lot of outside investors coming in and buying a home, expecting to rent it out. And that seems to correspond to bubble cities. So the first question is: Could it bubble up again? And I don’t know the answer to that. I suppose it could.


The question is, have people learned their lesson? Right now they are beaten down, but I don’t know that they have learned a lesson [about the dangers of housing bubbles]. In fact, they might have learned the opposite lesson--they may infer that there is going to be another bubble before too long, and they may pile into it. Of course, now the lenders won’t be so friendly about that. It seems conceivable that there could be price increases in these cities, especially if the lending situation improves.


But I’m not predicting that. I think the most likely scenario is that prices will be sluggish there for years. And maybe decline more. But, you know, they have gone down a lot. In real terms, since it’s been five years, they are down, in some cases, 60 percent because there is a lot of inflation over that interval. It’s been a huge drop. I find it hard to predict where it will go from here.


Q: As the number of foreclosures declines over time, along with the share of sales that are foreclosures, won’t that push up prices?


A: We might see more foreclosures next year because of the [delays we are having now due to the] foreclosure mess.


Q: What factors are favorable in areas where prices have come back? What is the outlook for those markets?


A: I’m thinking of San Francisco as a case where prices have turned up. They did so also, I think, around March 2009. It increased quite smartly until around June 2010. The market went up over 20 percent. San Francisco was the most dramatic city in price increases among our 20 major cities. San Francisco also had another price increase in 2001 that surprised me.


So, what to make of San Francisco? I don’t have answers to all these questions. It seems to me that our glamour cities are particularly vulnerable to bubbles, and California falls very much in that camp. When you have celebrities living there and tourists coming by to admire your city and you also have a history of repeated bubbles, I think people there are much more ready to see a new one coming.


The thing that can happen is that people [think a bubble could occur, then conclude,] if you are going to profit from coming into a market that is newly booming, you have to do it quickly. So, in the middle of a recession might be a perfectly plausible time to do that.


That’s how I think people are likely to think in some glamour cities with a history of bubbles. So it could happen again. The problem is that mortgage lenders are more difficult. The lending standards are much tougher. So it’s not as easy to get credit. If people get a whiff there might be another boom, then sellers will hold out. They are not going to sell their houses if they think another boom is coming. They also have the feeling of regret for having lost money [in the housing market decline], so they have a lot of emotional baggage that might lead them to hold out.


Q: Banks and investment banks are laying off thousands of people in New York, which has not seen a huge drop in housing prices. Would that further dampen prices in New York?


A: New York did have a drop. I’m comparing it with real prices in Boston and Washington, D.C. The New York market remains high--it is well above its value in 2002. So it’s a strong market overall, looking at the level of the index. Why is that? I can just speculate on that. You might also be surprised [that] after the terrorist attack in New York, people increasingly wanted to live there. I think it has something to do with the sense that this is the financial century and New York is the financial headquarters of the world, and that there is just great promise in that. Maybe the incipient trend toward urbanization--people want to retire in the city and live there.


Also, New York has solved a lot of its crime problems and it’s a better place to live now, compared to decades ago. So, it’s just looking up and up. It’s unique--Manhattan, particularly--but the sense of uniqueness is spreading out to other areas [in the other boroughs].


Q: What is your outlook for the new-home market? When will prices come back to historic norms?


A: Well, they will someday. The longer we go, the more backlog [of potential demand]. We’re not building enough homes. Right now it’s held back by a decline in the household formation rate. So young people aren’t moving out. And young immigrants aren’t moving in. Yes, eventually it has to pick up. It’s surprising how long construction has been in a slump and how dramatic that slump is. I don’t know how to predict when it’s coming back. You’d think it should come back before long. But if we have another recession, it could take years still.


Q: Do you think tight mortgage lending standards are holding back housing?


A: Yes. In fact, there have been studies of the lending standards and they are tighter, and that has to hold back housing.


I had a book in 2008 called (ital) Subprime Solutions. (end) I was offering a new kind of mortgage. . . . I call it a continuous workout mortgage. It would be a mortgage with a pre-planned workout.


Q: In case something went wrong?


A: Actually, I thought it would be continuous and based on home prices in the area and local incomes, so there would be some adjustments of amounts owed automatically. Now, this has to be priced in. Mortgage lenders are offering a kind of insurance when they do that. But we could price that in and securitize such mortgages, and investors could bear the risk. That was my futuristic idea that I thought would help prevent the next crisis.


So homeowners would find their workouts [would be] automatic. Right now, what’s been happening is that borrowers get a workout and things get even worse and they end up defaulting anyway. So I wanted to have the workouts respond instantly and continuously. If things get better, then your workout goes away. It’s not an option that’s one-sided. Make it respond to your economic situation.





Robert Stowe England is a freelance writer based in Arlington, Virginia. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..


Copyright ® 2011 by Mortgage Banking Magazine. Reprinted With Permission.



Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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