robert shiller imageCONSUELO MACK: This week on WealthTrack, Financial Thought Leader Robert Shiller forecast the bursting of the tech and housing bubbles. As he tracks the behavior of consumers, home prices, and markets, what does this visionary Yale economist see in our future? We’ll find out next on Consuelo Mack WealthTrack.

Full text and video below:

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Remember the days of the so called “great moderation,” during the Greenspan years of the 1990s and into the last decade when policy makers, CEOs, Wall Street pundits and many investors believed we had tamed the boom and bust economic beast and were forever destined to live in a Goldilocks economy of steady growth, low prices and near full employment? Did we ever really believe that? We sure did.
This week’s WealthTrack guest, Yale professor and noted behavioral economist, Robert Shiller wrote about it in a recent New York Times column, as quote “the origins of the current economic crisis… a particular kind of social epidemic, a speculative bubble that generated pervasive optimism and complacency.” As Shiller, who predicted both the tech and credit bubbles in several editions of his book, Irrational Exuberance told me, markets are driven by stories and word of mouth contagion.
The market story is far different today than it was a decade ago. This week alone we have more evidence of decelerating growth and nervous reaction to it. Revised second quarter GDP turned out to be slower than initially reported and below consensus forecasts. And more recent reports from several regional Federal Reserve banks are showing spreading weakness in business activity. In a much anticipated speech in Jackson Hole, Wyoming on Friday, where Federal Reserve Chairman Ben Bernanke announced his quantitative easing, or QE2, policy a year ago, the Fed chief acknowledged the economic deterioration, but did not announce any new initiatives to try to stimulate the economy.
Longer term, the markets are already reflecting the change in economic narrative. The S&P fell 16% from July 22 through August 19th, the biggest four-week loss since the market lows of March 2009. And price volatility is still with us, on both the up and downside. I began our interview by asking Professor Shiller to describe what he calls the “malaise” that we are experiencing.

ROBERT SHILLER: Not everyone will agree with this, but I think that there is some sense of hostility at the rich, hostility at our institutions like government, there is a sense of protracted disappointment. We’ve been in a slow period for five years, and there is some impulse to do finger-pointing and blame someone, and I think there is some deterioration in kind of our social compact that’s holding us together, which makes it harder to do business, and then it becomes, to some extent, a self-fulfilling prophecy.

CONSUELO MACK: Let me ask you about that. I know one of the things that you had told me when I had talked to you a couple of weeks ago was that when the S&P downgrade of U.S. Treasury debt occurred, that you felt that it actually damaged our national pride.

ROBERT SHILLER: Right. The pride that we have in this nation is very important, and by the way, it is supported by people in other countries. Other countries respect the United States, they may criticize it, they may be angry with it, but they respect it, as shown by the fact that they send their money to be invested here, even at low yields.

CONSUELO MACK: You’ve talked many times on WealthTrack about the importance of human psychology and attitudes, and so the complacency and optimism that we had prior to the financial crisis, for instance, so we’re seeing a change in that, and that kind of the cultural zeitgeist has changed. So how significant is that change, and is there anything- I mean, how easy is it to reverse it, and to bring at least the optimism in this country back, which is so important to the economy, right?

ROBERT SHILLER: We do have confidence indexes, which are low, but not super low. I mean, I don’t know that they capture all of the nuances that we need to capture. The thing that is really striking is in the housing market, that the interest in home buying has just plummeted. Now that is partly because it’s difficult to get a mortgage, but it’s not offsetting, that is mortgage rates are extremely low now by historical standards, so why is it that new home sales are so down, housing starts and permits are so far down that people just are not looking at houses now? I think it’s complicated. There are other factors, for example, the household formation rate is down so that people are less likely to move out from their parent’s house and go buy a house. I don’t know that there’s any clear explanation of this, but to me it’s partly just a loss of our spirit, of our sense that the country is moving forward, and I’m going to get out and do something, and it’s a little bit weakened now. It’s hard to pin this down, but I think it’s a factor.

CONSUELO MACK: So you’ve done actually surveys of home-buyers, or home owners, or potential home owners and about, you know, what their expectations for home price appreciation are, for instance. And they’ve changed dramatically (from like five years ago, ten years ago.

ROBERT SHILLER: That’s right. That is interesting, the expectation for home price- the median expectation at the peak of the market was something around 7% a year, and…

CONSUELO MACK: In 2005, you mean in 2006, it’s the peak. Yeah.

ROBERT SHILLER: Yeah. And now the median is down to 4 percent a year. It’s sagged gradually over five years, so it’s not like people react suddenly to some event, like Lehman Brothers was an event in September 2008, and there was a sharp crisis then, but the people didn’t suddenly change their expectation. It’s been sagging for five years.

CONSUELO MACK: And what’s so interesting is I know you and a couple other economists co-authored an article called “Wealth Effects Revisited”, and which concluded that the change in housing values continue to exert a larger and more important impact around household consumption, which, of course, is 70% of our economy, than do changes in stock market values.

ROBERT SHILLER: That’s right.

CONSUELO MACK: I mean, our attitudes towards homes, and the value of our homes, right, has a huge impact on the economy.

ROBERT SHILLER: Right. I think homes are more immediate and visceral than our stocks. Often stocks are held in a retirement portfolio, and for young people that’s so far away. I mean, they don’t even feel like they own it. It used to be in the 1990s, you could borrow against your home equity, and there were competing offers coming in in the mail every day to let you do that. Now that is happening less, and people are feeling damaged, “I had this wealth, I thought I was a millionaire”, or “I thought my home would soon be worth $1 million”, but now it’s going down and so it changes their willingness to spend. I think this is

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