Taming those 'animal spirits' for a housing rebound

It seems that there’s just nothing better than an old-fashioned boom-and-bust cycle in the housing market to reveal what economist John Maynard Keynes dubbed ‘animal spirits’ in the middle of the Great Depression. Harnessed appropriately, it fuels the ‘naïve optimism’ that builders and developers require to place risky bets on new developments, when a constant barrage of economic externalities can derail even the best-laid plans.

But when these spirits turn dark – as they have in this ‘Great Recession,’ aggregate human psychology can prevent lenders from lending, consumers from spending and homebuyers from venturing into sales offices far beyond what traditional economics alone would dictate.

It is precisely this type of phenomenon that economists Robert Shiller (the Yale University professor and co-founder of the S&P/Case-Shiller Index) and Nobel Laureate George Akerlof (a professor at UC Berkeley), discuss in their recent book, “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.”

Having recently read this book to review for the Inman News service, I also thought its lessons were appropriate for the building industry, given that it was housing which sparked the economic maelstrom in which we still find ourselves. As an adjunct to the review, I was also able to interview Dr. Shiller for a new show I’m hosting on BlogTalkRadio.com, The Housing Chronicles.

A primary thesis of the book is the failure of macro-economic theory over the past generation to properly account for these animal spirits, which can be subdivided into confidence, fairness, corrupt/anti-social behavior, the illusion of how money really works, and the stories that people and societies tell themselves to explain their place in the world. Somewhat like the 2005 book “Freakonomics,” the authors then apply these theories to questions ranging from why countries fall into depressions to why real estate markets seem to always go through cycles.

So what’s the solution to prevent these spirits from again running amuk? For starters – and jump-started by the combination of a newly liberal White House and a somewhat compliant Congress – the authors think we’re on the precipice of a major shift in macro-economic policy. Instead of the hands-off approach which catapulted Ronald Reagan to the Presidency more than a generation ago, tomorrow’s economy will involve a lot more regulation.

Yet in order to prevent this regulation from stomping out the entrepreneurial energy which will lead to a rebound, Shiller and Akerlof also suggest that both individuals and government will have to learn how the economy truly works, and then apply that knowledge to such vexing questions as investing in stocks or real estate, the practical administration of Social Security or healthcare, and how to balance financial goals against life’s many other decisions.

For builders and developers, this shift could also provide a great opportunity to revive or initiate seminars (or Internet-based webinars) on money management, how to appropriately budget for a homebuying purchase, and how to ignore those animal spirits which arise from short- or medium-term changes in the market in pursuit of a longer-term goal: that of paying off a house in which to live.

My review of "Animal Spirits" now online

Recently, I had the opportunity to interview Dr. Robert Shiller, the Yale University professor and co-author of the new book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism," which is now online at BlogTalkRadio. You can also access that interview by clicking on the BlogTalkRadio player on the right hand margin of this blog.

That review was published today by Inman News, which can find by clicking here. An excerpt:

Ever wonder why a seemingly slam-dunk deal suddenly gets thrown off the rails even though none of the terms have changed?

Perhaps you should blame "animal spirits" gone awry, a term economist John Maynard Keynes coined in the middle of the Great Depression to describe the type of "naive optimism" that is a necessary ingredient for businesses to invest, for entrepreneurs to take risks -- and for potential homebuyers to sign those documents at the closing table.

Left to their own devices, however, these same spirits can fall dramatically, thus becoming a psychological barrier to a properly functioning economy.

In their recent book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism," economists George A. Akerlof, a Nobel laureate and professor from University of California, Berkeley, and Robert J. Shiller, co-creator of the Standard & Poor's/Case-Shiller Index for home prices and a professor at Yale University, spent over five years researching, dissecting and explaining the importance of these animal spirits in the global economy.

It is their conclusion that longstanding theories of "rational expectations" and "efficient markets" are so flawed on their own that any credible economic models must take into account these spirits to avoid future catastrophes.

Read the entire interview here.

Interview with Robert Shiller now online at BlogTalkRadio

My interview with Robert Shiller, author of the new book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism" is now online at BlogTalkRadio. You can also listen to the interview by clicking on the widget on the right hand margin of this blog.

This interview will be accompanying my upcoming review of the book for the syndicated news service Inman News.

Home price declines flattening, but not evenly

Although the S&P/Case-Shiller national index is showing a flattening in the pace of price declines for the third month in a row, for various price ranges and different cities, the pain continues or is expected in the future. I'll be interviewing Dr. Shiller tomorrow at 12 noon (Pacific time) for my Housing Chronicles show on BlogTalkRadio.com, and I'm sure I'll be asking his opinion on these differences. From an L.A. Times story:

Home prices in 20 metropolitan areas were down 18% in April compared to the same month the previous year, according to the S&P/Case-Shiller home price index.

In the Los Angeles area, which includes Orange County, April home prices fell 21% from the previous year.

Los Angeles County and Orange County prices in April were down 42% from their 2006 peak, the index shows. The 20-city index was down 33% from its 2006 peak.

The Case-Shiller index had posted record year-over-year declines from October 2007 to January of this year. April's index was the third straight month in which the pace of price declines slowed slightly...

While Los Angeles area price declines have slowed, Charlotte, Chicago, Cleveland, New York, Portland and Seattle posted record year-over-year declines in April.

The worst year-over-year declines in April were in Phoenix (35%), Las Vegas (32%) and San Francisco (28%).

Los Angeles area price declines have varied substantially by price segments. The lowest-priced third of homes sold in April is down 54% in price from its peak, according to Case-Shiller; the middle third was down 42%; and the most-expensive third of homes sold was down 31%.

The lowest-priced homes in the Los Angeles area had more room to fall - they had also shown the largest price increases during the real estate bubble, with prices in that segment inflated by subprime lending...

Nontheless, because the mid-level and upper-price tiers depend largely on buyers moving equity from the entry-level tier, it's only a matter of time before we see price declines even out, and that process is already starting in certain markets.

Interview tomorrow with Robert Shiller, co-author of "Animal Spirits"

On Wed., July 1st at noon (Pacific time, 3pm Eastern time) I managed to snag an interview with Robert Shiller, Princeton University professor, co-founder of the S&P/Case-Shiller index and co-author of the new book "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism" for my Housing Chronicles show on BlogTalkRadio.com.

You can either listen to the first 15 minutes streamed live or listen to the podcast afterwards (I'll post a link). I'll be citing this interview for my upcoming review of the book for Inman News.

Next book review: "Animal Spirits"

For my next book review for Inman News, I selected the book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism" by economists George Akerlof and Robert Shiller.

The reason I chose it was because few markets are more prone to human psychology than residential real estate, so I was hopeful that the book would provide some tools to real estate agents to educate potential buyers when deciding to enter into a deal.

I'm also trying -- so far unsuccessfully -- to grab 15 minutes of Dr. Shiller's time for a brief, 15-minute interview for my HousingChronicles show on BlogTalkRadio (and also to help with my review). Since I've interviewed the authors of nearly every book I've reviewed for Inman News and the L.A. Times -- including other noted economists such as Richard Florida and Mark Zandi, who regularly testifies in front of Congress -- I was thinking Dr. Shiller would be willing to do the same.

However, since the PR rep for his publisher is having zero luck scheduling this interview, if any readers of this blog have any sway with Dr. Shiller, you'd have my gratitude to intervene. While the lack of an interview certainly won't stop me from writing the review, I'd find it much easier to tie it directly to the Inman News audience with a few specific questions. After all, this isn't the type of book to which your average real estate agent would gravitate, so I had to talk my editor into letting me review it in the first place.

According to Amazon.com, here's a description of the book:

The global financial crisis has made it painfully clear that powerful psychological forces are imperiling the wealth of nations today. From blind faith in ever-rising housing prices to plummeting confidence in capital markets, "animal spirits" are driving financial events worldwide. In this book, acclaimed economists George Akerlof and Robert Shiller challenge the economic wisdom that got us into this mess, and put forward a bold new vision that will transform economics and restore prosperity.

Akerlof and Shiller reassert the necessity of an active government role in economic policymaking by recovering the idea of animal spirits, a term John Maynard Keynes used to describe the gloom and despondence that led to the Great Depression and the changing psychology that accompanied recovery. Like Keynes, Akerlof and Shiller know that managing these animal spirits requires the steady hand of government--simply allowing markets to work won't do it. In rebuilding the case for a more robust, behaviorally informed Keynesianism, they detail the most pervasive effects of animal spirits in contemporary economic life--such as confidence, fear, bad faith, corruption, a concern for fairness, and the stories we tell ourselves about our economic fortunes--and show how Reaganomics, Thatcherism, and the rational expectations revolution failed to account for them.

Animal Spirits offers a road map for reversing the financial misfortunes besetting us today. Read it and learn how leaders can channel animal spirits--the powerful forces of human psychology that are afoot in the world economy today.

Keynesianism, Reaganomics and Thatcherism? I can't wait!

Can't wait for the interview? Buy the book at Amazon.com (now only $9.99), or click on the widget below:

Fortune magazine talks to 8 prognosicators

Dow 4000? Food shortages? A bubble in Treasury bills? Welcome to 2009, courtesy of 8 different visions of economists/analysts/businesspersons opining in Fortune magazine:

Nouriel Roubini

Known as Dr. Doom, the NYU economics professor saw the mortgage-related meltdown coming.

We are in the middle of a very severe recession that's going to continue through all of 2009 - the worst U.S. recession in the past 50 years. It's the bursting of a huge leveraged-up credit bubble. There's no going back, and there is no bottom to it. It was excessive in everything from subprime to prime, from credit cards to student loans, from corporate bonds to muni bonds. You name it. And it's all reversing right now in a very, very massive way. At this point it's not just a U.S. recession. All of the advanced economies are at the beginning of a hard landing. And emerging markets, beginning with China, are in a severe slowdown. So we're having a global recession and it's becoming worse...

Bill Gross

The founder of bond giant Pimco warned of a subprime contagion back in July 2007.

While 2008 will probably be best known as the year that global stock markets had their values cut in half, it was really much, much more. It was a year in which every major asset class - stocks, real estate, commodities, even high-yield bonds - suffered significant double-digit percentage losses, resulting in the destruction of over $30 trillion of paper wealth. To blame this on subprime mortgages alone would be to dismiss an era of leveraging that encompassed derivative structures of all types, embodying a belief that economic growth was always and everywhere a certainty and that asset prices never go down. As 2008 nears its conclusion, we as an investor nation have been forced to face a new reality. Wall Street and Main Street are fearful that a recession may be replaced by a near depression...

Robert Shiller

The Yale professor and co-founder of MacroMarkets called both the dot-com and housing bubbles.

We don't currently have anywhere near the level of unemployment that we had in the 1930s, but otherwise there are many similarities between today's environment and the Great Depression, with things happening today that we haven't seen since then. First of all, there's the magnitude of the stock market's move up and down. The real (inflation-corrected) value of the S&P 500 nearly tripled from 1995 to 2000, and by November 2008 was down nearly 60% from its 2000 peak. The only other comparable event was the one in the 1920s where real stock prices more than tripled from 1924 to 1929 and then fell 80% from 1929 to 1932. Second, we've had the biggest housing bust since the Depression. Third, we've seen 0% interest rates. We've actually seen briefly negative short-term interest rates. That hasn't happened since 1941. There was a period from 1938 to 1941 when we were bouncing around at zero and sometimes negative, but that hasn't happened since...

Sheila Bair

The FDIC chairman has been pushing to get mortgage relief for borrowers.

My 87-year-old mother is a native Kansan who grew up in the throes of the Great Depression and the Dust Bowl. She is a classic "buy and hold" investor who would make Warren Buffett proud. Her investment returns always exceeded those of my father, to his eternal consternation. He actively traded his stocks and produced decent returns, but nothing like those my mother achieved by simply buying stocks of companies she understood and liked, and then holding onto them...

Jim Rogers

The commodities guru predicted two years ago that the credit bubble would devastate Wall Street.

We are in a period of forced liquidation, which has happened only eight or nine times in the past 150 years. The fact that it's historic doesn't make it any more fun, of course. But it is a pretty interesting time when there is forced selling of everything with no regard for facts or fundamentals at all. Historically, the way you make money in times like these is that you find things where the fundamentals are unimpaired. The fundamentals of GM are impaired. The fundamentals of Citigroup are impaired...

John Train

The author and chairman of Montrose Advisors has 50 years of Wall Street experience.

I presume that although we are in a severe recession it will not decompose into a full-scale depression, because that is what everyone is afraid of and desperate to avoid. Wall Street likes to say that the market has anticipated five of the last three recessions - the point being that a market crash frightens the authorities into taking necessary action.

Keynes observed that pragmatic businessmen often could not imagine that they were the slaves of defunct economists, but ironically, never is this more true than today of Keynes himself. So we run a huge deficit to postpone the worst. That means inflation, so bonds are unsatisfactory...

Meredith Whitney

The Oppenheimer & Co. analyst was among the first to warn that the big banks had big problems.

What the federal government has done so far- with TARP, bailing out Citigroup, etc. - has stemmed the bleeding, but what it hasn't done is fundamentally alter the landscape. Yes, there's been a tremendous amount of capital thrown into the system, but my concern is that it's just going to plug the holes. It's not going to create new liquidity, which is what the system so desperately needs...

Wilbur Ross

The billionaire chairman of W.L. Ross & Co. specializes in turning around troubled companies.

We are clearly in a serious recession, and more aggressive action is needed to turn things around. The federal government initially underestimated the scale of the mortgage and housing crises and later panicked into an ever-changing series of ad hoc measures that at best dealt with some of the effects of the original crises. But homeowners have now lost $5 trillion, and 12 million families have mortgages in excess of the value of their homes. Therefore the economy will not stabilize until mortgages are adjusted down to the value of homes, with affordable payment schedules, and until new mortgages become available across the home-price spectrum. Till then, the poverty effect of falling house prices and unemployment moving up toward 7% will hold consumer spending back from its former 70% contribution to our economy.

The long-term damage of foreclosures

Perhaps the most important thing I've learned reading comments on housing blogs is how many people (especially the knee-jerk "No Bailout!" crowd) don't really understand macroeconomics. I can certainly see why -- when I was in college I used to joke, "I'm an econ. major but that doesn't mean I'm boring!" because the array of numbers, tables and graphs in beginning economics classes was enough to put most people to sleep (something I've discussed with economics professors I know, but they're very committed to the teaching of theory first).

Where economics gets interesting is in the application of its theories, and few places test the combination of psychology and money more than in the housing market, which is actually a giant puzzle of various trade-offs. That's why it's interesting that Dr. Robert Shiller -- co-founder of the S&P/Case-Shiller housing price index and a Princeton professor -- opined in the New York Times over the weekend that the rising foreclosures in this country, coupled with the often hypocritical tsk-tsks of the less tolerant, could very well have a long-term impact on the psychology of the American consumer. Frankly, I'm just happy that an economist has emerged from his ivory tower long enough to see things from a perspective that isn't simply an objective discussion of numbers alone. From his article:

ACROSS the United States, there were 243,353 foreclosure filings in April alone, nearly three times the total in the same month just two years ago, according to RealtyTrac, a company that follows the numbers. The trend is unmistakable, and suggests that, without government intervention, many millions of American families will be losing their homes before long.

It’s easy to take a stern view of this spectacle. The arguments go something like this: Foreclosure is not the end of the world. There are valuable lessons to be learned from such a life experience. After all, we live in a capitalist economy that thrives on the sanctity of contracts. The founders of our nation put the contract clause into the Constitution to make it clear that people need to live up to the documents they sign...

This stern view may, in fact, be winning the battle of public opinion. On May 9, the House approved legislation aimed at helping some of the people facing foreclosure, but the president has said he would veto it...

Now, let’s take the other perspective — and examine some arguments against the stern view. They have to do with the psychological effects of strict enforcement of a mortgage contract, and economists and people in business may need to be reminded of them. After all, too much attention to abstract economic statistics just might make us overlook what is really important.

First, we have to consider that we cannot squarely place the blame for the current mortgage mess on the homeowner. It seems to be shared among mortgage brokers, mortgage originators, appraisers, regulatory agencies, securities ratings agencies, the chairman of the Federal Reserve and the president of the United States (who did not issue any warnings, but instead has consistently extolled the virtues of homeownership).

Because homeowners facing foreclosure must bear the brunt of the pain, they naturally feel indignation when all of these other parties continue to lead comfortable, even affluent lives. Trying to enforce mortgage contracts may thus have a perverse effect: instead of teaching homeowners that they should respect the contracts they sign, it may incline them to take a cynical view of the whole mess.

But instead of having sympathy for these homeowners, many people blame them for their predicaments. That isn’t surprising. It’s an example of a general tendency that was documented by social psychologists decades ago.

In his 1980 book, “The Belief in a Just World: A Fundamental Delusion,” Melvin Lerner, a social psychologist, argued that people want to believe in the inherent justice of the economic system in which they live, and want to believe that people who appear to be suffering are in fact responsible for their own situations. He provided empirical evidence, derived from experiments, that after an initial pang of sympathy, people tend to develop negative views toward others who are suffering. That negative tendency seems to be at work today.

Second, it is important to consider the psychological trauma of foreclosure. No one is likely to starve or sleep on the streets as an immediate result of a foreclosure, and the authorities no longer dump a family’s furniture on the sidewalk when it happens. Nonetheless, there is deep trauma.

Homeownership is fundamental part of a sense of belonging to a country. The psychologist William James wrote in 1890 that “a man’s Self is the sum total of all that he CAN call his, not only his body and his psychic powers, but his clothes and his house, his wife and children, his ancestors and friends, his reputation and works, his lands and horses, and yacht and bank account.”

Homeownership is thus an extension of self; if one owns a part of a country, one tends to feel at one with that country. Policy makers around the world have long known that, and hence have supported the growth of homeownership.

MAYBE that’s why President Bush’s “Ownership Society” theme had such resonance in his 2004 re-election campaign. People instinctively understand that homeownership conveys good feelings about belonging in our society, and that such feelings matter enormously, not only to our economic success but also to the pleasure we can take in it.

But we are now seeing the president’s Ownership Society plan operate in reverse. Already, the homeownership rate has fallen — from 69.1 percent in the first quarter of 2005 to 67.8 percent in the first quarter of 2008. That’s almost back to the 67.5 percent level where it stood when Mr. Bush took office in 2001. And it is likely to fall further.

The pain of this reverse movement could leave a psychological scar that will be with all of us for the rest of our lives.