If you want to know what's going on in the U.S. housing market, chances are you follow the Case-Shiller index. Robert Shiller, the Yale University economist who helped create the home-price gauge, was something of a pop economist even before the real estate meltdowna book published in 2000 warning about the coming crash in stocks made him a rock star of the last bubble, too. His latest book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters For Global Capitalism , was written with University of California, Berkeley economist George Akerlof. Shiller spoke with TIME's Barbara Kiviat.
People are talking about the housing market bottoming out. Do you believe it?
The conspicuous fact with our [Case-Shiller] data is that prices are still falling, although at a somewhat lower rate. There is also some sign of pick-up in pending-home sales. But to me the dominant fact is that prices are still falling. We've never seen a real estate market turn on a dime. For the longer horizon, though, it's possible that we are picking up. The other thing that is striking is that home prices have come down a lot, so they're no longer very overpriced.
If houses are no longer overpriced, but prices are still falling, does that mean we're overshooting?
That is the issue, whether we'll overshoot and end up being below, in inflation-adjusted terms, where we were in 1997. We're not quite down to where we were before, but we're getting close. Overshooting is typical in the stock market, but in the housing market, I don't know. We've never really had such a big, national bubble in the housing market before.
Are there structural changes we need to make so that we don't have this sort of craziness again?
Yes. This crisis was substantially caused by a failure to manage real estate risk. Notably, we got individual homeowners into a leveraged position typically with their entire life savings in real estate in one city, in one house. That's very risky. I have one proposal for continuous workout mortgages. Right now we think it's a great thing if banks will give struggling homeowners a workout. Why do we only want to come in after the fact? My vision for our future is that it should be planned for and priced into the initial mortgage. We could update mortgages in a way they protect people from things beyond their control like high national unemployment.
What else?Home-equity insurance. We want to have homeowners' insurance, which protects against things like fires, updated so that it protects against a loss of market value. Fires were a big problem hundreds of years ago. Houses were burning down all the time. Now we've developed a different problemthe residential housing market has gotten much more volatile.
The company you started, MacroMarkets, just got approval for tradable securities linked to the Case-Shiller house-price index. How does that factor in?
One reason we have bubbles in the housing market is because there's been no way to short housing [that is, to make money when prices fall]. The ability to short is essential to an efficient market, otherwise there's nothing to stop zealots from pricing things abnormally high. If you buy one of these long securities, called UMM, it's like buying a house, except you don't have to go through the real estate agent, take possession of a property, maintain it, rent it out. But we also have the DMM, which is short housing. Markets like this will also create an infrastructure for products. For example, insurers could issue home-equity insurance and then hedge themselves by taking a position in this market.
The Case-Shiller housing futures that trade on the Chicago Mercantile Exchange haven't really taken off, though.
I know. It's bizarre. People are fascinated by housing they want to read the home section of the newspaper and gossip about it. But they don't seem to want to trade it. I think it's all a matter of getting it right. And we continue to work on it. It's like insurance. They invented life insurance in the 1600s, but it didn't become common until the 20th century.
What are your thoughts about the economy more broadly are you seeing 'green shoots?'
What we're seeing now is some renewed optimism, and it could develop into something, but it's still too early to know. In the Great Depression we had a recovery after '33it wasn't a full recovery, but it was a recovery. So it's entirely plausible that we could be there soon. But a full recovery didn't come until 1947/1948. We really messed up our system for now, and it's going to be hard to have a full recovery. But we could have further gains in the stock market and an end to the home-price declines.
To what extent do you think we'll learn from everything that's happened? How long before we start making mistakes again?
We do have memory that goes for generations. I was struck by an LA Times article that I saw from 1886, after the Los Angeles housing bubble. The writer said something like Californians have learned. Never again will we allow real estate speculation to go so far. And he was kind of right. I don't think California had another massive real estate bubble until the 1970s. After a hundred years, we're allowed to forget, right?
But we've had credit bubbles, and there were other asset bubbles, too like Internet stocks.
I don't think there's any perfect solution, because the essence of a free-market economy is that people are allowed to make mistakes. And some of these bubbles have a good side. The Internet bubble of the 1990s brought us Amazon and eBay. They're still with us. Stabilizing the economy isn't the final goal. Having a little bit of turmoil, as long as it doesn't get out of hand, is part of creative destruction.You have a history of highlighting parts of the economy that have gotten out of hand before other people are paying attention. What's next?
I don't know if I'm ready to make any big announcements. I'm worried about the tremendous expansion of the Fed's balance sheet and unwinding that, but I suppose we'll probably do that all right. I'm worried about the anger that's developing. People have tolerated a lot of inequality, but in light of recent events, I could see social changes. But that's not forecasting a bubble.