Housing and Economists: A for Good Behavioral
Economic bubbles mess with the laws of supply and demand. Yale’s Robert Shiller calls the pscyhological factors that defy these laws ”Animal Spirits.” M.I.T.’s Dan Ariely explains counter-supply-and-demand behavior as “Predictably Irrational.” The University of Chicago’s Richard Thaler describes policies and programs that reduce the number of Homer Simpson “Doh” moments as an goal that reckons with human foibles and failures in decision-making.
- People think, “there is a greater fool out there than me.”
- Statistically, 60%-plus people think they’re smarter than the rest, which can’t be.
- Some fair number of us think we’re above the law.
- Lots of us believe we won’t get caught if we do something wrong.
Here’s a priceless thought from Ariely that helps clarify how strict Adam Smith rules fall short when it comes to understanding the dislocation of the moment:
I found this quote in a wonderful book called 3 men in a boat. The book was written in 1889 by Jerome K. Jerome, and interestingly it does not seem that much has changed since then.
I knew a young man once, he was a most conscientious fellow and, when he took to fly-fishing, he determined never to exaggerate his hauls by more than twenty-five percent.
“When I have caught forty fish,” said he, “then I will tell people that I have caught fifty, and so on. But I will not lie any more than that, because it is sinful to lie.”
Here’s a piece by Thaler in the New York Times that helps clarify how mortgage products are not created equal, and that most borrowers thrive on more rigidity in the loan structures while a very few might do well with “exotic” loans, providing they have been certified and qualified.
First, inexperienced borrowers are steered toward the vanilla mortgages, the terms of which are chosen to be easy to understand. Vanilla mortgages would be the equivalent to the green runs at ski resorts that are intended for novices. The rocky-road mortgages would at least come with warning labels (“Don’t even think about going down this run unless you are an expert skier, or have a trusted professional instructor by your side”), and it is possible that for very exotic mortgages, borrowers might have to demonstrate that they understand the risks or have been aided by a certified mortgage planner.
Here’s a quote in today’s NY Times from Harvard economist Edward Glaser:
One major point of economics is that predicting asset prices is extremely hard, and that goes for housing as well as stocks. Moreover, the last seven years should make everyone wary about predicting housing price changes.
At this point, not only is our foresight limited but our hindsight isn’t exactly 20-20 either. The housing price volatility of the last six years has been so extreme that it confounds conventional economic explanations. Over a four-year period — from February 2002 to February 2006 — the Case-Shiller index increased 68 percent in nominal terms or about 50 percent in constant dollars.
Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom, and we built hundreds of thousands of additional homes. Our current low levels of construction will continue until we work through all of this extra housing stock.
We expect our economists to forecast the future, but how can they when several of the assumptions traditionally used to understand the present have been proven wrong?
It’s refreshing to hear an economist say he or she doesn’t really know what’s next. Especially one who might have hit the nail on the head years ago to predict where we are now.
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