Robert Shiller’s home pricing analysis has created panic in the hearts of every home owner, every bank lender, home builder, the managements at home furnishing suppliers, lumber companies, cement companies and etc. Lending businesses of every type and description are in shear panic of a highly uncertain and dire future. I believe that Shiller’s widely disseminated forecast needs perspective.
My first observation is that Robert Shiller makes a broad forecast using the complete period from 1890-2008. When I view his data it is apparent that crucial events in 1933 enabled the Federal Reserve to not only provide economic stabilization during times of distress but to set national baking regulation. My interpretation is that by lessening the downturns in our economy caused by a pre-1933 unregulated financial industry, the Federal Reserve lessened the capital destruction and the US economy and housing stock grew out of post-1933 economic declines from serially higher lows. The effect in home valuations and the gradual willingness to use borrowed funds has provided fulfillment to many American dreams. I have drawn valuation channels for these two very different economic periods and added rates of return that came from this analysis in the chart below. Robert Shiller treats the 1890-2008 price series as having a continuous economic environment.
I had puzzled over Shiller’s forecasts for some time as they appeared so dire, yet the history in the NAREIT above and the Nominal Housing Prices below did not fit the oft repeated forecasts.
The Shiller House Pricing Data is Inflation Adjusted, BUT we think in terms of the Nominal Price and banks lend against the Nominal Price.
Shiller’s forecast is an inflation adjusted forecast, but the media does not present it this way. We think in Nominal Prices, the price we see every day. When Shiller compares price declines during the last home price decline period to those of the current period as is presented in Chart 3 from paper-money.blogspot, these are inflation adjusted prices and not those that we actually experienced in the decline of the late 1980’s-early 1990’s. We experienced a 3% Nominal Price decline from 1990 to 1991. Importantly, banks lend against the Nominal Price not the Inflation Adjusted Price.
Our national panic over falling prices and owners being underwater vs. Inflation Adjusted Cost Basis is not how we or the banks think. It seems that we have suddenly come to accept a pricing methodology that we have never before considered valid.
In my view the current panic heavily promoted by the media needs to step back a bit and not take Robert Shiller’s price decline forecast as a Nominal Price decline forecast which is what I think we are doing.
