8 Responses to “Economists: we’re right, half of the time” »»

1. anon
   Comment by anon | 01/29/08 at 7:59 pm

   Maybe that’s because they are predicting where prices *should* be. They missed the 100% rise because it was due to people behaving irrationaly. Given that prices rose more than was justified, a fall is necessary to bring them back to where they *should* be. The problem is, people don’t behave rationally, and so prices don’t either.

2. Gus
   Comment by Gus | 01/29/08 at 8:20 pm

   Economist Robert Shiller made a similar point in an Op-Ed piece in the WSJ a few months ago. He was trying to answer the question of whether this boom is due to economic fundamentals or buyer psychology.

   He stated that by 2000 not one single economist had predicted that real estate prices would explode over the next five years. He thought if there were real economic reasons for a huge nationwide boom, some of the signs would have been evident to at least one economist out of the many thousands who study the US economy.

   He claimed this supports the notion that prices have been driven by expectations of higher prices, which drive more buyers to buy in ever more leveraged fashion, which causes still higher prices, which lure still more buyers into the game, in a vicious circle.

   He also mentioned that once you get into 2002 and 2003, there were many economists predicting future large gains, as they were increasingly caught up in the bubble psychology. I can’t find the article now to reference who they were, but I know then NAR economist (and super optimist) David Leereah was quoted all over the place saying real estate was on the way up, way up, for the long haul. (In 2000, a couple of months before the stock market crashed, Mr. Leereah wrote a book extolling the stock market as the road to wealth and made only a passing reference to real estate).

   I found this prediction from Freddie Mac in 2005, where they expected housing price increases of 8% and 6.7% in 2005 and 2006, respectively. This rate would have prices doubling in less than 8 years. http://www.mortgagenewsdaily.com/3142005_Freddie_Mac_Housing_Outlook.asp
   I’m pretty sure there are countless other similar predictions.

   I don’t believe “just about everyone believes the pros, going the other way”. If everyone, or even a lot of people, did, (whether or not economic fundamentals justified it) no one (or those lots of people) would buy, and prices would crash.

3. John A Keith
   Comment by John A Keith | 01/29/08 at 8:40 pm

   Ha ha.

   Although he’s a buffoon, you have to say then that Lereah was right, probably 70% of the time, which is pretty good for your typical economist.

4. Um…
   Comment by Um… | 01/29/08 at 9:39 pm

   Are you kidding me? The economists at one of the most widely read international newspapers called… uh.. The Economist were screaming “This is a bubble!” YEARS ago. They warned for a very long time over and over again that this wouldn’t end well. They started to sound like Cassandra after a while. But they were right and here we are.

5. Anon
   Comment by Anon | 01/29/08 at 10:20 pm

   The real estate bubble was triggered by the Fed lowering interest rates to record low levels in 2002. Who could have predicated this was going to happen in 1995, 1998, or even 2000?

6. John A Keith
   Comment by John A Keith | 01/29/08 at 10:24 pm

   Exactly my point. Obviously, economists can only make best guesses based on currently available information and past experiences.

   Plus, how can an economist make any accurate predictions when you have a central bank acting independently and without regard for basic concepts of economics?

7. Anon
   Comment by Anon | 01/30/08 at 8:35 am

   Hi John,

   Point taken. While investment bubbles are hard to predict in advance, the results are not. Bubbles burst and people loose money.

8. Gus
   Comment by Gus | 01/30/08 at 1:17 pm

   The predictions people make are important indicators, not for their face value, but as a measure of sentiment.

   At first, sentiment is neutral. As asset values increase, the market observers become increasingly optimistic, which drives prices higher in a self reinforcing cycle. Also, the perceived risk is diminished, so credit is extended and accepted in ever greater amounts.

   Finally, at the peak of optimism, all the money that can go in is already in, credit is stretched to reckless levels by unworried participants who feel invulnerable. Since there is no more money to go in, the upward price movement stops.

   Then some trigger occurs. In this case, it was defaults on subprime mortgages issued in 2006, some without even one payment having been made. Since all the money is in, it has only one way to flow, out.

   In asset bubbles, the next phase is bad publicity and the beginnings of broad negativity, but there are still many looking for the quick soft landing. This is when the unsustainability of the bubble is exposed and instances of fraud are uncovered.

   This pattern has been repeated dozens of times since the modern financial era began in Holland 500 years ago. The only element in the classic bubble that is missing from this bubble is the development of heroes who are leading the way to the new economy. What happens next is a bit variable, but the end has never been in question. It ends badly. Very badly.

   It is possible that the bubble can reinflate, pushing asset prices higher for years, until it finally bursts again. It is possible it can slowly deflate over a large number of years, torturing the economy all the way down (Japan anyone?).

   It is most likely to snowball downward as panicked participants run for the exits before they are bankrupted. Credit availability goes from wide open to shut, as a results of fear and diminished capital from loses.

   At this phase the negativity builds until finally there is revulsion. People don’t want to have anything to do with the asset, are embarrassed to tell others they own it, won’t buy it even when it gets cheap. In fact, asset prices typically overshoot on the downside and can be a great deal for those who buck the trend and buy (e.g. Boston real estate 1992).

   Nobody knows how this will unfold. This could be different from all those other times.

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