Shiller on Why Valuing Banks' Real Estate Holdings Is 'Simmering Problem'
Robert J. Shiller, a Yale University economist and the namesake of the closely watched Standard & Poor's/Case-Shiller home price indexes, has been called overly pessimistic for predicting home prices could fall another 25%.
But don't forget that in 2006, Shiller broke from the pack by accurately predicting the housing bust. He claimed price increases had far outpaced construction costs, rents and income.
And so far, there's been little evidence to the contrary of his latest forecast. The S&P/Case-Shiller U.S. National Home Price Index, which he co-developed with the economist Karl Case, hit a new low in the first quarter as repeat home sales sank to 2002 levels.
Shiller, who is also co-founder and chief economist of the investment management firm MacroMarkets LLC, recently spoke with American Banker about his glum outlook on housing, why the qualified residential mortgage rule might not be such a bad thing for banks, and on getting mail from disgruntled homeowners.
You're predicting a further 10% to 25% decline in home prices. What's the rationale behind those numbers?
ROBERT SHILLER: We're kind of at a tipping point. I wouldn't be surprised if we saw a real 10% to 25% decline in the next few years. That means prices would be down about 12% in real terms not keeping up with inflation. It's not an outrageous forecast.
So we're still far from a bottom?
The thing is we have an unusually bad situation. The mortgage market is being supported by Fannie Mae, Freddie Mac and the Federal Housing Administration. It's really political right now. That's why it's hard to forecast. It's also about the mood of the country because with 9.1% unemployment, people are not in the mood to buy houses right now. They can wait. It's a risky time, so they're waiting. That's why there's more and more talk about renting and about home ownership not being the only American dream.
Do you think banks are able to verify the underlying collateral of their real estate holdings?
That's a simmering problem. We don't know how bad off the banks really are and they might get worse off from here if home prices continue to fall. Now the government is less warm to the idea of a bailout because the public got mad the first time around that it was a bailout of the rich. That's another reason to worry about the future.
Are banks dealing with their bad loans?
We've had these two rounds of stress tests and in the second round some people thought there wasn't enough pressure on the banks to tell the truth. So we really don't know. I don't think there's any pressure for it.
How do you measure fundamental value in real estate particularly in a falling market?
That's hard to do. I have a chart plotting home prices back to 1890 and what's stunning is home prices were constant for 100 years from 1890 to 1990. So we could overshoot. A 10% drop would mean in nominal terms home prices are just where they are now. So banks would be where they are now, maybe there would be more defaults. A 25% decline would mean a 15% drop in nominal home prices and that's going to put a lot more people under water and a lot more banks.
It's not possible to be quantitative in these forecasts. It's an unusual situation. This is the biggest recession since the Great Depression and it was a real estate-driven recession. Also it was an international event. The only thing offsetting the declines is that construction activity has virtually stopped.
Aren't you concerned about a vicious cycle of price declines?
It is true that we haven't been building for years now so the supply is short and the population is still growing. But the other side, housing prices are not going to be in free fall because people hold out and they don't sell.
Existing home sales are not high so you can't explain it entirely in terms of sales volume. Most people can wait to sell their homes, which slows down the economy somewhat because then they don't move and won't take jobs that require moving.
Then again, it could be even worse than what I'm predicting but I don't want to say so. If there were a 25% decline in home prices, it would put more households underwater, and there might be a social change to encourage walking away.
People still feel they have American values and they pay their loans. If it gets bad enough and people feel their needs are not being addressed, that could change.
What do you think of Dodd-Frank and specifically the requirements for a "qualified residential mortgage?"
It's an interesting idea that originators should retain some interest. The question that comes to mind is why do we need the government to tell us this? We would have thought everyone would have learned that already. Maybe it's a good thing. I wasn't involved in advocating that. It does create another layer of regulatory complexity.
All those things that Dodd-Frank asked for is all a morass. It was ambitious in many ways but they left all the details to be determined by regulators and it's a big job that could take years.
Now there are people saying the lobbying system favors the rich and there has to be an element of truth to that.
Generally the word lobbyist is an obscene word. I think the government relies on them to inform them about what the interests are but it does mean some bias. It's part of the debate and part of the reason why it's hard to do anything for the banks.
Should we have such low interest rates? Are we creating another bubble?
That's the same thing that happened in the Great Depression, interest rates stayed low and it didn't stimulate demand. That led [John Maynard] Keynes to write about the liquidity trap when interest rates are zero and nobody wants to lend.
You've been called a pessimist for your stance on housing. Is that a hard position to be in?
I recently got a letter from someone in Texas saying I'm poisoning the market. There aren't that many [pessimists] so it is a little difficult. I look forward to the day when I can be the opposite. The professional forecasters are getting progressively less optimistic.
Also, our president doesn't want to be pessimistic and a lot of people think it's unpatriotic to be pessimistic. But it would have been good if people had listened to the pessimists in 2005.