Robert Shiller: How a Bubble Stayed Under the Radar

One great puzzle about the recent housing bubble is why even most experts didn’t recognize the bubble as it was forming.

Alan Greenspan, a very serious student of the markets, didn’t see it, and, moreover, he didn’t see the stock market bubble of the 1990s, either. In his 2007 autobiography, “The Age of Turbulence: Adventures in a New World,” he talks at some length about his suspicions in the 1990s that there was irrational exuberance in the stock market. But in the end, he says, he just couldn’t figure it out: “I’d come to realize that we’d never be able to identify irrational exuberance with certainty, much less act on it, until after the fact.”

With the housing bubble, Mr. Greenspan didn’t seem to have any doubt: “I would tell audiences that we were facing not a bubble but a froth ”” lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.”

The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.

Were all these people stupid? It can’t be. We have to consider the possibility that perfectly rational people can get caught up in a bubble. In this connection, it is helpful to refer to an important bit of economic theory about herd behavior.

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Posted in * Economics, Politics, Economy, Housing/Real Estate Market

7 comments on “Robert Shiller: How a Bubble Stayed Under the Radar

  1. Mithrax+ says:

    The Economist magazine was talking about the housing bubble at least a year before it burst.

    Same with the dot-com bubble.

    I’ve learned that when major media start talking about how to make money quick with current trends, it’s the time to bail out.

  2. Festivus says:

    I had to question AG, but many continued to ignore the issue to capture new customers – couldn’t let their competitors have them. People have debt upon debt, and borrow too much on homes, then borrow against equity, and you can’t see what the result will be down the road? Some got out of the sub-prime mess and had very high lending standards, so some saw it. I, for one, and perfectly content with a tighter market and letting the failure run their course, but the Fed Gov has chosen to bail people out of stupid decisions. Look for the interest rates to be driven lower for people can make their payments. When inflation happens due to the lenders making the same mistakes, I wonder if they’ll say they didn’t see it yest again?

  3. Cennydd says:

    We’ve seen what happens a a result of the “housing bubble” here in Los Banos, CA. As a result of the explosive growth of the housing industry locally… own home included…..we’ve found it necessary to pass a $40M+ bond issue in order to ensure adequate schooling for our children…..while at the same time, the bubble burst…..with the resulting foreclosures. Fortunately, many of the homes being foreclosed are now being sold…..albeit at a loss to the lending institutions, who are now a lot more picky about who they’re dealing with… they should have been all along.

  4. Statmann says:

    A factor little recognized is that the Baby Boomers (now approching Social Security and Medicare) chose to have many fewer children. And millions of illegal immigrants will provide care for them in the nursing homes but not have the money with which to buy their empty nests. Statmann

  5. Bill Matz says:

    In 2003-4, i walked away from 3 different purchases (north of San Francisco). Although my warnings of a bubble were a couple years early, it was clear that the price rise was unsustainable.

  6. Adam 12 says:

    For more than a year and a half folk in the East have been worried about selling their homes at a decent price…and there have been plenty of stories about this in the paper. I think it was a recognized problem…it seems to be that the secondary debt market was too detached from the reality of worst-case housing pricing and that may be where the real problem lies. Certainly if interest rates come down people with existing mortgages can refinance. Also this unsold inventory should become a lot more attractive.

  7. Sidney says:

    I agree with others that the housing bubble was visible long ago. But still, the theme that amazingly bright people can be tremendously wrong about very simple things is one worth digesting. It’s true about lots of things, especially religion…

    We’d be wise to assume that we could all be fools.