Lunch with the FT: The man and the bubble - The Yale professor correctly predicted the last stock market crash five years ago.

Lunch with the FT: The man and the bubble - The Yale professor correctly predicted the last stock market crash five years ago in his book, Irrational Exuberance. Now he is predicting a property meltdown.
By Jim Pickard
Published: February 17 2006 19:29 | Last updated: February 17 2006 19:29. Copyright by the Financial Times

Before meeting Robert Shiller, I take a long stroll in London’s Kensington Gardens, despite the Baltic weather. This is because a) I arrived 30 minutes early at our lunch venue, Launceston Place in Kensington, and b) I have not thought up enough intelligent questions to challenge one of the world’s most famous economists.

The Yale professor correctly predicted the last stock market crash five years ago in his book, Irrational Exuberance. Now he is predicting a property meltdown.

As I walk, my mind turns back six years to when I was interviewed for my first job at the FT. A senior editor had picked holes in my local newspaper cuttings. “Do you know anything about economics?” he sneered. My younger Oxfam-clad self replied that I had an A-level in the subject. “And you still wrote this!”

As I arrive at the restaurant, I wonder whether the professor will make a similar assessment.

He is already sitting in the corner of the restaurant and I offer him a chilly hand.

He looks a bit like Brian Wilson, one of the Beach Boys, with sandy hair and - for a 59-year-old - young features. He wears a blue jacket over a light blue shirt.

On his wrist he wears a VibraLITE3 watch, which he tells me “has a vibrating alarm that makes no appreciable noise” so as not to wake his wife in the mornings.

Shiller has sold truckloads of books by using plain English and eschewing more arcane economic theory. But he is not averse to more complicated words.

I ask how he would describe the homely but deserted Launceston Place - which I chose because it is accessible from Heathrow as he is lunching with me en route from New Haven to Geneva. He thinks for a while before replying: “Gemutlich.”

“It probably applies more to German restaurants,” he says. “They say it doesn’t have an exact translation into English... it refers to a warmth... although ideally there should be more people singing and drinking beer.”

What I really want to know, not least as a homeowner, is when and how the property market will crash. So I ask him.

For a man whose written predictions seem so definite - and dire - he appears loath to be nailed as an inveterate doomster. “I really don’t know what prices will do,” he says hesitantly, playing with his cutlery.

But hasn’t he predicted a huge drop in US house prices? Only in some specific cities and states, he clarifies.

The professor is no doubt aware that the history of economic forecasting is littered with the names of those who made the right forecasts at the wrong time.

He was already well respected before he became an author. Indeed, he may have been the one who lent Alan Greenspan the phrase “irrational exuberance”, having used the expression in a meeting with the chairman of the Federal Reserve in 1996, just two days before the latter famously uttered the phrase in a speech that sent stock markets into a temporary tailspin.

Yet Shiller’s life has changed since Irrational Exuberance was published in 2000. He now gives a dozen speeches a year to business audiences across the world and makes frequent media appearances.

As the starters arrive - black pudding for him, cauliflower soup for me - I ask if all the attention has affected his academic work. In the cloistered world of Yale, do fellow academics look down on him for reaching out to the public in layman’s language?

“Is there jealousy? Definitely. Not that anyone would say that to me, but there is social pressure,” he says. “It is not that people frown on it as much as they think it is not the real thing.” He even admits that he has felt obliged to set “really tough” questions for students to prove his intellectual virility.

By now the two tables behind us have filled up, creating a little more atmosphere in the restaurant.

Alan Greenspan was praised for his handling of the economy during his interminable run as head of the Fed; in particular for his rapid cuts in interest rates to keep the economy afloat after the last stock market crash.

Yet this has pumped up the housing bubble even more. I want to provoke mild-mannered Shiller into a little criticism. What, exactly, can Ben Bernanke, Greenspan’s successor, do to rescue the US economy if the property market crashes? Has the Fed already used up its one silver bullet - that of interest rate cuts?

“Bernanke thinks there is no housing bubble,” says Shiller. “According to the White House website, he said recently that the fundamentals explained house price movements except in some speculative markets.” The new chairman of the Fed is a “brilliant man”, Shiller continues, but he has not shown any interest in behavioural economics.

And this is where he has underestimated the danger posed by real estate speculation. “He is not attuned to one of the great innovations of our time, that is, bringing psychology back into economics.”

Here we come to the crux of Shiller’s theories about asset bubbles, whether tulips, shares or property: people get excited as they see the price of an asset rising, so they buy more, which pushes the prices up further until they are unsustainable. “The bubble is made by a ‘story’, by excitement and glamour,” he says. And then, once a market loses that momentum, it will experience negative feedback, where people rush to sell before things worsen further.

It is no coincidence, as Shiller readily admits, that he is married to a behavioural psychologist.

I tend to agree with his analysis, but don’t want to look like one of his more supine students.

First, I ask, is he underestimating the role of low interest rates in fuelling the global property bubble? Prices may seem ridiculously high but if the cost of servicing property debt is low, why should it matter?

Shiller’s reply seems well-rehearsed: interest rates are not so low in a historical context and in the US they are rising. An unprecedented number of variable rate mortgages (they have doubled in two years) spells danger for the American public, he says.

My second criticism is that it is not enough for an academic to point out when a market has over-heated. It’s only really useful to know when a market is so over-heated it will implode. In other words: timing. It is a point that he concedes. “If I knew the answer to that one I would be a very rich man,” he jokes.

By now we are picking our way through the main course. We have both ordered cod with rice.

I interrupt Shiller to ask what he thinks of the food. “The fish is a little bland,” he says. He is right - it tastes like an anodyne kedgeree.

One striking theme within Irrational Exuberance is Shiller’s preoccupation with greed. He writes about the 60-fold rise in gambling in the US since 1962 and suggests that this new-found appetite for risk has spilled over into how people approach investment.

The real estate bubble, he argues, has simply replaced the last stock market bubble as the focus of people’s avarice. This seems rather judgmental, I suggest. Is he a moralist? He mulls the question. “I might have a puritanical streak. I don’t gamble,” he says.

He has never been to Las Vegas. His only trip to a casino was in Monte Carlo, in the company of one of his adult sons, where - inevitably - he lost his 100 euros.

Later, as Shiller eats a poached pear with cinnamon ice cream - which he declares delicious - we discuss his own investment approach. If the professor thinks that property and shares are both overheated, then where would he invest? Under a bed in cardboard boxes?

Shiller’s advice is to diversify and to keep plenty of money in the bank or in “boring” inflation-proofed bonds.

But he does own two properties: one in New Haven and another - bought with the proceeds from the sale of a research company he founded - on Long Island Sound. There, where there is no electricity, he watches the stars by telescope.

He can name every star that is visible to the naked eye and seems disappointed by most people’s ignorance of the night sky.

“Some people don’t even know that we live in a galaxy, the Milky Way, that you can see. They say: ‘What’s that up there?’ It amazes me that people aren’t interested.”

A few days later, Shiller (”Bob”) sends a rambling e-mail to clarify some of the things he said over lunch (”relaxed conversation is one of the great blessings of human life, but in my opinion it suffers from our faulty memories and getting the facts wrong”).

Much of the e-mail dwells on gemutlich, and whether it was an appropriate description for Launceston Place. Apparently so. “It refers more to a general ambience of social warmth or tradition or something like that,” he writes.

Elsewhere, he talks of the relationship between mathematics and economics and psychology. He is keen to correct any impression that he is dismissive of the mathematical side of economics, of which he is a “huge admirer”.

It’s just that - and I paraphrase - the number crunchers have ignored the bigger picture.

“One practically has to be a renaissance man (woman) to achieve good work in economics,” he writes, “and contemporary life does not give us enough time to do that.”

Jim Pickard is the FT’s property correspondent.