Robert Shiller and Home Prices

By this time, about 6 years after the peak in home prices, most of us are somewhat familiar with the "Case-Shiller Home Price Indices."  Even the "talking heads" on the evening news can now say this rapidly 5 times in succession without fumbling. We've been listening to these indexes (indices) being quoted or reading about them since the housing peak. However, where did these indices come from?

The "Shiller" in "Case-Shiller" refers to Robert Shiller, a professor at Yale University. Professor Shiller is the co-creator of the "Case-Shiller" indices. The professor has a web site, and it has some interesting tid-bits. Here's a graph constructed from his spread sheet data for "Home Prices since 1890." You can get this and more by going to Prof. Shiller's website, which is contained in the notes for this post.

The historical data for the chart is updated at Professor Shiller's website four times a year. This data is in Prof. Shiller's excellent book "Irrational Exuberance" [Princeton University Press 2000, Broadway Books 2001, 2nd edition, 2005].

The above chart indicates long term changes in home prices, the overall trend in home prices, building costs, population and interest rates. As you can see, prices currently are below the trend line. What does that mean? It implies that for prices to return to their trend, that they will increase. However, as can also be seen, home prices can be depressed below the trend for periods of time. Notable is 1918-1945, a span of 28 years with below trend prices; of course, there were four recessions in the period 1918-1927, the great depression, world war II, dust bowl and other economic hardships and restraints during that period. Prices also fluctuated during the period 1967-2000, and yet, during that time, a lot of people made money in real estate. That was before the now infamous bubble! So I would caution anyone to avoid making gross conclusions simply based on this chart, or to make predictions.  

One item of interest is the rise of population and the trend line for home prices. They track reasonably well. It may be a coincidence or not. The chart does not have information on rentals. The population has two choices of where to live; in a home which they "own" or in a rental unit. 

A second item of interest to me is the rise in building costs in the period 1970-1982. What was the primary cause? During that period, the economy experienced "oil shocks" and the Arab Oil Embargo, the Iranian revolution, Iran/Iraq war and price controls in the U.S. But why, even with high oil prices in recent years, have construction costs moderated? Here is a chart from the Council On Foreign Relations which provides some insights. It shows the spending for oil as a percent of GDP. Many aspects of home construction cost are governed by oil prices. They include materials, materials processing costs, fabrication and even the cost of transportation to and from the job site and on site construction costs. Clicking here will open the original article:

New Window> Revisiting the U.S. Economy and High Oil Prices

Returning the the Shiller chart, it becomes somewhat obvious that something was drastically wrong with "Home Prices" from 2000 to 2006. Never mind that Federal Reserve Chairman Greenspan, the National Board of Realtors (R) and just about everyone else who stood to make a profit took the position that "There is no bubble! What bubble?" 

As we have learned, bubbles aren't a problem unless you are one of the unfortunates who purchased late in the game, just before the music stopped. Hmmmm, somewhat reminiscent of a "Ponzi Scheme" on a grand scale, in which the early birds get rich, and the rest of us get to "hold the bag" when the music stops! However, I would say that home owners should take heart. The U.S. population is growing, the cost of rentals is increasing, home prices are below the trend line which implies a current purchase is a bargain, and it is most likely that prices will eventually turn in a direction of the trend line. In the mean time, I suggest we enjoy our homes and condos, and be thankful for the roofs over our heads. 

Notes:

1. Shiller is Stanley B. Resor Professor of Economics at Yale University.
2. His book "Irrational Exuberance" gave Nobel Laureate Paul Krugman of New York Times fame, the insight and courage to begin talking about "the bubble."  
3. In "Irrational Exuberance" Prof. Shiller explains the psychological underpinnings which cause people to listen to others against their own best judgement.  He successfully skewers the experts and gurus who so many of us listen to and rely upon. And those are the bright ones! Prof. Shiller doesn't even bother with the "talking heads" who are mere parrots. 
4. If you are interested in Prof. Shiller's website, which contains links and information about books he has written, click here: New Window> Prof. Robert Shiller Website