NYT: Don't the Farm on the Housing Recovery

By ROBERT J. SHILLER

MUCH hope has been pinned on the recovery in home prices that began about a year ago. A long-lasting housing recovery might provide a balm to households, mortgage lenders and the entire United States economy. But will the recovery be sustained?

Alas, the evidence is equivocal at best.

The most obvious reason for hope is that, unlike stock prices, home prices tend to show a great deal of momentum. Correcting for seasonal effects, home prices as measured by the S.&P./Case-Shiller 10-City Home Price Index increased each month from June 1995 to April 2006, then decreased almost every month to May 2009. Since then, they have risen through January, the latest month for which data is available.

So, because home prices have been climbing of late, isn’t it plausible that they’ll keep doing so?

If only it were that simple.

Home price booms and busts do end, sometimes quite suddenly, as was the case for the boom of 1995 to 2006 and the bust of 2006 to 2009. Today, we need to worry about strong headwinds, as the government begins to withdraw its support of a still-troubled lending industry and as foreclosures are dumping millions of homes onto the market.

Consider some leading indicators. The National Association of Home Builders index of traffic of prospective home buyers measures the number of people who are just starting to think about buying. In the past, it has predicted market turning points: the index peaked in June 2005, 10 months before the 2006 peak in home prices, and bottomed in November 2008, six months before the 2009 bottom in prices.

The index’s current signals are negative. After peaking again in September 2009, it has been falling steadily, suggesting that home prices may have reached another downward turning point.

But why? Unfortunately, it is hard to pinpoint causes for a change in demand for housing. The factors clearly include government economic policy, like interest-rate changes and tax credits. But these moves don’t line up neatly with major turning points in the market.

Sociological processes may be driving these changes. Trends in news media coverage, for example, generate conversations in barbershops and hotel lobbies, which in turn alter the conventional wisdom about investing.

Consider how that process might have worked during the run-up to the 2006 turning point in home prices. In May 2005, two months before the peak in the N.A.H.B. traffic index, Consumer Reports magazine had a cover article, “Your Home: How to Protect Your Biggest Investment,” that conveyed a very bullish sentiment.

“Despite years of dire warnings from some economists that the housing boom is about to end, it hasn’t,” the magazine said. “Indeed, last year prices rose even more — about 11 percent nationally.”

The article went on to give advice: “You can no more time the real estate market than you can the stock market,” it said. “If you need a house, and can afford one, go ahead and buy.”

The article extended to the housing market the conventional wisdom that then prevailed about the stock market — namely, that it was quite efficient, without identifiable bubbles and bursts. According to this theory, there was an identifiable profit opportunity: buy and hold stocks, and by extension, housing, and watch your wealth grow.

But as 2005 continued, the conventional wisdom began to change.

Some people in the United States were by then aware of the 2004-5 home price decline in Britain. Some were learning a new lexicon: “housing bubble,” “housing crash” and “subprime mortgage.” Newspapers and magazines began to include some derisive reviews of a March 2005 book by David Lereah, “Are You Missing the Real Estate Boom?” And accounts began to appear of the risky behavior of an army of real estate flippers.

In May 2005, I included in the second edition of my book, “Irrational Exuberance,” a new data series of real United States home prices that I constructed, going back to 1890. I was amazed to discover that no one had published such a long-term series before.

This data revealed that the home price boom was anomalous, by historical standards. It looked very much like a bubble, and a big one. The chart was reproduced many times in newspapers and magazines, starting with an article by David Leonhardt in The New York Times in August 2005.

In short, a public case began to be built that we really were experiencing a housing bubble. By 2006 a variety of narratives, taken together, appear to have produced a different mind-set for many people — creating a tipping point that stopped the growth in demand for homes in its tracks.

THE question now is whether a strong case has been built for a new bull market since the home-price turning point in May 2009. Though there is no way to be precise, I don’t believe it has.

Since that turning point, most public discourse on housing has not been about a new long-term view of the market. Instead, it focused initially on whether the recession was over and on the extraordinary measures the government was taking to support the housing market.

Now we’re shifting into a new phase. The recession is generally viewed as being over, and those extraordinary measures are being lifted.

On March 31, the Federal Reserve ended its program of buying more than $1 trillion of mortgage-backed securities, and the homebuyer tax credit expires on April 30.

Recent polls show that economic forecasters are largely bullish about the housing market for the next year or two. But one wonders about the basis for such a positive forecast.

Momentum may be on the forecasts’ side. But until there is evidence that the fundamental thinking about housing has shifted in an optimistic direction, we cannot trust that momentum to continue.

Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.

Copyright 2010 The New York Times Company. All rights reserved.