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Wednesday, June 17, 2009

"Unlearned Lessons"

Did the false belief that land suitable for building houses was becoming scarce help to drive the housing bubble?:

Unlearned lessons from the housing bubble, by Robert J Shiller, Project Syndicate: There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.

That misunderstanding encouraged people to buy homes for their investment value – and thus was a major cause of the real estate bubbles around the world whose collapse fuelled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends. Indeed, some people are already starting to salivate at the speculative possibilities of buying homes in currently depressed markets.

But we do not really have a land shortage. Every major country ... has abundant land in the form of farms and forests, much of which can be converted someday into urban land. ...There are often regulatory barriers to converting farmland into urban land, but these barriers tend to be thwarted in the long run if economic incentives to ... become sufficiently powerful. It becomes increasingly difficult for governments to keep telling their citizens that they can’t have an affordable home because of land restrictions. ...

Many people seem to think that the US experience is not generalisable, because the US has so much land relative to its population. ... But, to the extent that the products of land (food, timber, ethanol) are traded on world markets, the price of any particular kind of land should be roughly the same everywhere. ...

Shortages of construction materials do not seem to be a reason to expect high home prices, either. For example, in the US, the ... Building Cost Index ... has actually fallen relative to consumer prices over the past 30 years. To the extent that there is a world market for these factors of production, the situation should not be entirely different in other countries.

The ... expectations for real estate prices ... during the recent bubbles were often totally unrealistic. A few years ago Karl Case and I asked random home buyers in US cities undergoing bubbles how much they think the price of their home will rise ... on average over the next ten years. The median answer was sometimes 10% a year. ... Home prices cannot have shown such increases over long time periods, for then no one could afford a home.

The sobering truth is that the current world economic crisis was substantially caused by ... speculative bubbles ... made possible by widespread misunderstandings of the factors influencing prices. These misunderstandings have not been corrected, which means that the same kinds of speculative dislocations could recur.

In general, even though I don't always share Shiller's psychological approach to economic problems, it seems to be a bad idea to bet against his forecasts, in this case that people will once again misperceive that the real cost of housing is flat or slightly declining in the long-run, instead they will forecast long-run increases, and this will generate yet another housing bubble.

Update: Richard Green says "Shiller is largely right but for two things."

    Posted by on Wednesday, June 17, 2009 at 04:56 PM in Economics, Financial System, Housing | Permalink  TrackBack (0)  Comments (27)


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