Sunday, January 29, 2006

A Quote

So I was re-reading some of Shiller's book Irrational Exuberance today. I was interested in the chapter (chapter 11 - "Investor Learning and Unlearning") where he discusses the possibility that the stock market has only recently become a rational market due to the general investing public having recently learned some "facts" about the market. For example, leading up to the pop of the stock market bull run of the late 90's people had learned such "facts" as "stocks always outperform other investments, such as bonds", "the stock market always quickly recovers after a major decline", etc., and that the reason for the huge price movements and their expected future continuation was because the market had become rational.

He concludes the chapter with this:
A similar process of investor "learning" appears also to have been going on in connection with other markets besides just the stock market. People have been "learning" that investments in homes are really not risky, that homes are the "best" investment. The perception that the public has just learned some important facts lends support to massive market price increases by encouraging the belief that these increases may be permanent.

The sense that we are all suddenly learning important facts and have arrived at a new enlightenment about investment has appeared so many times in history that it may be regarded as a predictable component of irrational exuberance. We must consider how to deal with the change in thinking that leads people to think we have entered a new enlightenment, changes that, through their effects on market prices, impinge on all our lives.

We have to consider what we as individuals and as a society should be doing to offset some of the ill effects of this exuberance.

pp. 202-3
The next section is appropriately entitled "A Call to Action".


Blogger peterbob said...

I don't have the book, but someone told me that he shows that the long run real rate of return on housing is zero. In other words, in the long run, after you subtract inflation and maintenance, housing is a poor place to invest.

My grandmother celebrates 50 years of living in her house this year (Chicago). She told me what she paid for it, and based on what it would sell for today, I calculate that her nominal rate of return was 7%. After you subtract inflation, taxes, and other costs, there isn't much left. I checked with my folks who have lived in their same home for almost 35 years, and they have a similar rate of return.

This is just one more reason why I believe that housing prices in California, which have seen price increases of 20% for a few years, will fall or remain flat for many years to come.

Jan 29, 2006, 11:47:00 AM  
Blogger Marinite said...

I don't have the book, but someone told me that he shows that the long run real rate of return on housing is zero. In other words, in the long run, after you subtract inflation and maintenance, housing is a poor place to invest.

Yes, that is very true... he does. Housing is not a great investment in the long run. The data he presents is pretty hard to argue against.

Jan 29, 2006, 11:50:00 AM  
Blogger Econ_101 said...

Related to your post is another finding of Shiller's (somewhere in the book). The idea is this:

By the end of a bubble (in any asset) people's perception of future risk and returns will be wildly inaccurate. That is, at the end of the stock runup, surveys showed investors felt stocks were both safer than ever before and likely to yield higher returns (than at pre-bubble times).

You will note that both perceptions were false - stocks were, in fact, very risky, and the returns were aweful.

We are at the same place with RE now (in the bubble zone). Expectations are that it is very safe and likely to have a high return. If history is any guide, both these perceptions are soon to be debunked.

Jan 29, 2006, 1:20:00 PM  
Anonymous Anonymous said...

Along the same lines as the previous post, consider that we are in the 4th year of a stock market rally where most advisors think there will be "modest" appreciation in domestic stocks this year.

Just like with housing, that sounds to me like like inaccurate perception of future risk and returns.

Something to think about when you are allocating your 401k contributions for the year...

Jan 29, 2006, 8:57:00 PM  
Blogger Rob Dawg said...

The problem with housing as just an investment is that it ignores the value of living someplace for free. It may not come anywhere close to a monthly SPDR investment but you can't sleep in an index fund.

Jan 30, 2006, 9:34:00 AM  
Anonymous Anonymous said...


Numerous people (including my parents) are multimillionaires due to investing in real estate. Not sure how they accomplished it with a zero rate of return, as you claim. However, I do agree that prices are in for a flat spell.

Jan 31, 2006, 8:50:00 PM  

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