It’s nice, you know, to kiss your beau
While cuddling under the mistletoe
And Santa Claus you know, of course
Is one of the boys from home
The door is always open
The neighbors pay a call
And Father John before he’s gone
Will bless the house and all
How grand it feels to click your heels
And join in the fun of the jigs and reels
I’m handing you no blarney
The likes you’ve never known
Is Christmas in Killarney
With all of the folks at home
Christmas In Killarney — Bing Crosby
Looking for something interesting to read over the holiday weekend? Try this:
As you might imagine, I am a fan of Robert Shiller. The PDF link above is to his latest paper.
Exerpts The real estate market changed its direction markedly around 1990, from a booming market to a market in the doldrums for the better part of a decade, and then the market started accelerating upwards at increasing rates. The national home price boom since the late 1990s appears unprecedented in US history, although the “baby boom” in housing of the late 1940s and early 1950s comes close, and there have been some very large local booms. The rate of US housing appreciation slowed after 2005, and, to some eyes at least, it would appear just sometime after mid 2006, we are entering a new regime of downward price changes.
It would seem that demand for housing services should be relatively inelastic in the short run, especially with regard to the number of units (rather than their size). Most families want just one house. The decision to own two or more houses, or the decision to break up the family to spread out over more houses, is not made very often—most commonly only at important life turning points or job changes. It is difficult for builders to transform two small housing units into one larger unit, or one large unit into two small housing units, without great costs. Hence, even small changes in the number of housing units might be expected to cause major short-run changes in home prices. However, home prices do seem to show enormous momentum, and sudden changes in the market seem rare. In a speculative market, a sudden change in some component of supply or demand may produce little price change if people think that the change is temporary, and so another component, a speculative component, offsets the sudden change. But the speculative component is inherently psychological, potentially unstable, and subject to contagion and herd behavior. People may change their mind about whether a change in price is only temporary or is the beginning of a new trend. They are especially likely to change their mind because we have professional marketers whose job is to get some kind of social response moving, and, when they do find some advertising pitch that resonates with investors, they will run it for all it is worth.
Analysis of past booms seems to indicate that investors in both the stock market and the housing market seem often not to understand the supply response to price increases. These are normal intelligent people, why would they repeatedly make the same mistake again and again? There seems to be what I will call a uniqueness bias, a tendency for investors to overestimate how unique an investment they favor is, failing to take account of the inevitable supply response to high prices. The uniqueness bias is reflected in quite a number of anomalies of human judgment that psychologists have documented, including the “representativeness heuristic,” “overconfidence,” “wishful-thinking bias,” “spotlight effect” and “self-esteem bias.” The uniqueness bias is related to failure to imagine how many possible competitors there are, a tendency to think highly of oneself and one’s associates and an association of investments with one’s sense of personal identity with an identified business model.
The uniqueness bias has its effect in the housing market when people imagine that the city they live in is unusually attractive, and increasingly so. They fail to understand that new such cities can be constructed in what are today cornfields or forests. In their 1990 paper, “The Baby Boom, The Baby Bust and the Housing Market,” N. Gregory Mankiw and David Weil argued that the housing market would soon crash as the baby boomers retired, neglecting to consider how supply would adjust to any such change in demand. In their 2004 paper “Superstar Cities,” Joseph Gyourko, Christopher Mayer and Todd Sinai argue for extrapolating some long-standing trends in major US cities, arguing that these superstars will only grow in status, assuming implicitly that there can be no new supply of the services those cities provide.
These narrative accounts do not prove anything, and we do not know that the change in thinking that appears to accompany ends of booms was in any sense the cause of the end of the boom. The change in thinking cannot be measured accurately, as we have only media accounts that suggest at it, that represent some journalists’ impressions that may not be replicable. Some economists would therefore be inclined to exclude any such effects from the economic model of the boom, and to try to explain the change in terms of some more well-measured economic effects.
But, if one considers that the prices paid for houses, as for any other speculative investments, surely reflects people’s willingness to pay, then the change in attitudes must have had an impact on prices. Just because we cannot precisely quantify and prove such an effect does not mean we should revert back to a null hypothesis that the changing psychology has no effect on home prices.
The best guess is that ends of housing booms have multiple causes, and cannot generally be interpreted as just an unraveling of boom psychology. Still a rising sense of enthusiasm and excitement for the investments, followed by a sense of betrayal and embarrassment at having fallen for the boom and underestimating the supply response to the boom, played a significant, if unquantifiable, role in the booms and their subsequent break.