One of three American economists who won the 2013 economics Nobel prize on Monday for research into market prices and asset bubbles expressed alarm at the rapid rise in global housing prices.
Robert Shiller, who shared the 8 million Swedish crown ($1.25 million) prize with fellow laureates Eugene Fama and Lars Peter Hansen, said the U.S. Federal Reserve’s economic stimulus and growing market speculation were creating a “bubbly” property boom.
The Royal Swedish Academy of Sciences lauded the economists’ research on the prices of stocks, bonds and other assets, saying “mispricing of assets may contribute to financial crises and, as the recent global recession illustrates, such crises can damage the overall economy.”
This was the case in the collapse of the U.S. housing market, which helped trigger the 2008-2009 global financial crisis. Markets are at risk of committing the same error now, Shiller told Reuters after learning he had won the Nobel prize.
“This financial crisis that we’ve been going through in the last five years has been one that seems to reveal the failure to understand price movements,” Shiller said.
Bubbles are created when investors fail to recognize when rising asset prices become detached from underlying fundamentals.
Shiller and other economists warn that prices in some markets have risen too far, too fast due to the Fed’s ultra-easy monetary policy. The benchmark U.S. Standard & Poor’s 500 index hit a record in September, though it is generally not considered overvalued based on expectations for corporate earnings results or economic growth.
Shiller’s work led him to suggest in 2005 that the U.S. housing market might be overheating. He helped create a closely watched gauge of housing prices, the S&P Case/Shiller Index.
In June this year, he pointed to a potential new housing bubble in some of America’s largest cities.
“It is up 12 percent in the last year. This is a very rapid price increase right now, and I believe that it is accelerated somewhat by the Fed’s policy,” he said.
China, Brazil, India, Australia, Norway and Belgium, among other countries, were witnessing similar price rises. “There are so many countries that are looking bubbly,” he said.
The Fed has held U.S. interest rates near zero since late 2008 and almost quadrupled its balance sheet to around $3.7 trillion through a campaign of bond buying, or quantitative easing, to hold down long term borrowing costs.
Placing more emphasis on avoiding asset price bubbles, and financial stability in general, has been a controversial topic for many years in policy-making circles.
Central bankers traditionally try to avoid targeting asset bubbles with a blunt instrument like interest rates. But the severe harm done when a bubble bursts means that, in the United States at least, they are thinking more broadly about the unintended consequences of their monetary policy decisions.
“When asset prices are getting way out of line it should be cause for alarm. The monetary authorities should lean against extreme asset price movements,” Shiller said.
The bubbling housing market is not mainly the result of central bank policy, but reflects a shift toward “a more speculative attitude,” Shiller said. “We cannot expect monetary policy to cure all of these problems.”
Hansen struck a more cautious note. “We often underestimate how much uncertainty there is in terms of our understanding of the economy,” he said. “If you pretend that we know more than we do, you are in danger of constructing policies that can be counter-productive.”
DIFFERENT THINKING ON MARKETS
The Royal Swedish Academy of Sciences said the laureates’ insights “provide guidance for the development of theory as well as for professional investment practice”.
Fama, tipped as a Nobel winner for many years, has been called the father of modern finance and is well-known for research showing certain groups of stocks tend to outperform over time, and for thinking about markets as efficient.
This view of how assets are priced is at odds with Shiller’s belief that investors can fall prey to “Irrational Exuberance,” the title of his 2000 book, shortly before the bursting of a global bubble in information technology stocks.
Hansen, who voiced caution about the ability of economists to spot asset bubbles in advance, said there were different ways to interpret evidence.
“In terms of overall understanding I guess there is a sense in which one could view them as complimentary,” he said of the research of his co-winners. “But right now, they would both have very different guesses about what is the right set of models going forward,” he said in an interview.
Fama and Hansen are professors at the University of Chicago, while Shiller is a professor at Yale University. Collectively, with research spanning decades, their work helped the emergence of index funds in stock markets, the award-giving body said.
Peter Englund, professor of banking at the Stockholm School of economics and member of the prize committee, said their research had deeply influenced modern finance.
“The most obvious application, that follows on from Fama’s research, is the insight that you can’t beat the market. It is impossible to prove that equity analysis is worth the money,” he told Reuters.
“That has led to the development of index funds and that most households actually put their savings in index funds.”