“…we should be hoping for better financial arrangements, a democratised and humanised financial capitalism, not for some price increase. We should be hoping for prices that are formed in markets in which all people participate with realistic expectations, prices that reflect contracts that treat everyone fairly and that reward good behaviour.
Thinking that large home price increases would be a good thing seems very widespread. But the effects of any such future price boom would not be so clearly beneficial, and would depend on the causes of the price increase and the financial arrangements that were made for them. The issues are much more complex than most people seem to imagine.”
“Price increases were related to a loosening of credit standards and weakening of the banking system due to complacency about the possibility of price falls. The result has been serious trouble in the banking sector, and the necessity for government bailouts.”
“Home price increases were also related to unrestrained and unrealistic public expectations for future price increases. In a survey of homebuyers in four US cities that Karl Case and I carried out in 2004, at the peak of the housing expectations, we found that the (trimmed) mean home price increase expected for the succeeding 10 years was 12.6 per cent a year. Maybe our respondents didn’t quite understand what they were implying: that would mean more than a tripling of home prices in the succeeding 10 years from an already high level.
At the least, home buyers must have thought they would make a ton of money: those who borrowed 90 per cent of the money to buy their house in effect saw their investment levered up 10 to one, and so these high expected price increases would be magnified 10-fold for their investment. No wonder people felt so pleased with the boom while it lasted.
Already eight of those 10 years have passed, and the actual rate of increase in US nominal home prices on average for the eight years was minus 3.6 per cent a year. Long-term public expectations were way off. And yet, even in the fact of this evidence, expectations have come down only slowly and gradually. Expectations for annualised 10-year price increases dropped to 5.6 per cent a year by 2011, though that is still high: it would imply a doubling of home prices in about a dozen years.”
“We should also hope for some fundamental change in our mortgage institutions so that the problem that got us into this housing crisis will not be repeated. In my book I talk about new types of privately issued mortgage that would go a long way towards preventing the kind of financial crisis we have just been through. I have proposed a continuous workout mortgage that has a pre-planned and continually adjusted workout written into the original mortgage contract. Issuers of such mortgages would be in effect selling insurance on home price declines as part of their mortgage package.
[My colleagues and I] have shown how these mortgages should be priced to yield a normal profit for private issuers. By creating such mortgages, issuers would be bringing the financial theory of risk management to the broader public, thereby helping to democratise finance.
We should also hope for better liquid markets for home price risk that would provide price discovery for future home prices, and a hedging vehicle to help mortgage originators to better kinds of mortgages without overburdening themselves with home price risk. That would be more good news.
Ultimately, what we really should be hoping for is not home price increases but democratisation and humanisation of the financial infrastructure. Such improvements are unambiguously good, and are things we can make happen. It need not be just a hope.”
- excerpts from ‘The property predicament’, by Robert Shiller, Financial Times, 21 Apr 2012 Shiller is a professor of economics and finance at Yale University,
[Image from same article]
Shiller’s suggestions may seem irrelevant to those desiring ‘affordable housing’ in Vancouver but they are not. Our bubble is the result of the same mispriced risk (too easy lending) and “unrestrained and unrealistic public expectations for future price increases” to which Shiller refers.
The particular problem for us is that we are at a different stage of the cycle, our bubble remains inflated. We believe that far and away the most probable outcome is very large price drops.
Perhaps some of the suggestions that Shiller and his colleagues make could be incorporated into our Canadian mortgage system, but we anticipate there will be little appetite for this until our housing markets suffer very severe setbacks.