Robert Shiller tips a double-dip recession

Financial Review

PUBLISHED: 18 Feb 2012

Anna Bernasek New York

Predicting a market boom or bust is not for the meek. Partly a matter of good timing and partly about being bold, a correct call can turn the forecaster into a star overnight, sought after by the global banking glitterati and invited to A-list events such as the World Economic Forum in Davos.

A bad call, on the other hand, can mean years of ridicule, quickly becoming fodder for endless jokes. Remember the book Dow 36,000?

Then there’s Robert Shiller, who’s in a class of his own. An economics professor at Yale, Shiller not only called the dotcom bubble of the late 1990s and the more recent devastating housing bubble but he warned that both would end badly. Very badly.

Remember back to when previous Federal Reserve chairman Alan Greenspan first used the term “irrational exuberance” to describe the booming market of the late 90s? He lifted that phrase from Shiller, after the economist had given the Fed chief a private briefing.

When the dotcom bubble burst in 2000, Shiller was vindicated and his book published earlier that year, Irrational Exuberance, became a hit. Between 2000 and 2002, about $US5 trillion of value was wiped out of the sharemarket.

Soon after, Shiller turned his attention to the housing market. Along with two other economists, Karl Case and Allan Weiss, Shiller developed a national housing price index in the early 1990s. The index gave those studying the market much more accurate observations of price.

Working through the numbers, Shiller became more and more convinced that the housing market was entering dangerous territory. From as early as 2003, Shiller appeared on television and radio – a lone and persistent voice warning about a national housing bubble. In late 2006, home prices peaked. Since then, they’ve fallen 33 per cent, unleashing one of the worst economic recessions ever.

This week I caught up with Shiller to find out what he thinks about in the post-bubble economy. It turns out there’s still plenty to worry about, except perhaps bubbles.

“My worry right now is that confidence is still shaky,” Shiller says. With Washington in gridlock, “we don’t have Keynesian tools available – we can’t do the big deficit spending at the moment, and we can’t do bailouts because of Dodd Frank. We’ve been tearing down our usual defences and now we are vulnerable”.

Despite recent signs of strength in the United States economy, Shiller predicts a double-dip recession. He defines double dip as a recession that occurs before employment returns to normal.

“Something will come along and tip the economy down,” he explains. “We’re at risk of that now. The European crisis comes first to mind but it could be anything. We don’t really know what causes recessions but we know they come along every few years.”

As for predicting what happens to housing prices, Shiller is less confident. “It’s become very difficult to know what will happen next,” he says. “Housing prices have come down to a more normal level and given interest rates, housing is pretty affordable. But prices could overshoot.”

What adds to the uncertainty, he explains, is the government’s role in the mortgage market and a lack of available credit for borrowers.

Since last northern autumn, housing prices have begun to fall again, surprising many commentators who believed that the market had stabilised. Shiller wonders whether the resumption of declining prices reflects a permanent shift in public attitudes to housing.

“The big question is whether people still think that they really have to get into housing or they’ll miss out on life. There’s evidence people may be just fine with renting instead.”

And just in case there’s any complacency about the housing market, Shiller adds that in Japan, following the property bust that began in the late 1980s, home prices continued their decline – with only minor interruptions – for 20 years.

A prolific author, Shiller’s next book, due out this spring, is called Finance and the Good Society. The impetus for the book was his students. Shiller says that most of his students end up in finance and he wanted a book to help them think about the bigger picture and address moral questions.

“I was working on this book a long time before the Occupy Wall Street Movement came along. People will think I’ve written it in response but I haven’t,” he says.

“People are angry about the banks and I hope the Occupy Movement likes this book. The central theme is the democratisation and humanising of finance. I take as reality that we’re not going to abolish banks or see bank presidents take a big pay cut. And I focus on how can we make finance work better.”

As for any bubbles on the horizon, Shiller pauses. “There are a few bubbles in housing in certain other countries,” he says. “I’m looking at Norway and Canada, for instance.”

And then he says quietly, almost as an after thought: “And there may be an oil price bubble.”

Will Robert Shiller be right three times in a row?