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Todd Robbins Irrational Exuberance

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					Irrational Exuberance: A Comparative
 Look at Housing Price Movements in
           the U.S. and U.K.


         Todd Robbins, Major, USAF
         NS 3041, Winter 2009
                          Real Home Prices




Source: http://mysite.verizon.net/vzeqrguz
                             Real Home Prices




Source:
http://mysite.verizon.net/
vzeqrguz



                                                    Real House Prices                                                                                                               Trend
                             £210,000
                                                    Source: Nationwide Building Society
                             £190,000
                             £170,000               Base : 2008 Q4
                                                    Trend from 1975 Q1 to present
                             £150,000               Trend = c2.9% per annum
                             £130,000
                             £110,000
                              £90,000
                              £70,000
Source:                       £50,000

http://www.nationwide.co      £30,000
                                        1975 Q1

                                                  1977 Q1

                                                            1979 Q1

                                                                      1981 Q1

                                                                                1983 Q1

                                                                                          1985 Q1

                                                                                                    1987 Q1

                                                                                                              1989 Q1

                                                                                                                        1991 Q1

                                                                                                                                  1993 Q1

                                                                                                                                            1995 Q1

                                                                                                                                                      1997 Q1

                                                                                                                                                                1999 Q1

                                                                                                                                                                          2001 Q1

                                                                                                                                                                                     2003 Q1

                                                                                                                                                                                               2005 Q1

                                                                                                                                                                                                         2007 Q1
.uk/hpi/historical.htm
                    Overview


•   Fundamental Basis for Home Prices
•   U.S. and U.K. Demographics
•   U.S. and U.K. Interest Rates
•   U.S. and U.K. Per Capita GDP
•   U.S. and U.K. Housing Prices
•   Shiller’s Irrational Exuberance Model
•   Conclusions
          Home Price Fundamentals


•   Location, Location, Location
•   Population and Population Growth
•   Mortgage Interest Rates
•   Income level
•   Construction Costs
Location, Location, Location
                               U.S./U.K. Demographics
                                 Population Growth
       350

       300

       250

       200
                                                         U.K. Pop (mil)
       150
                                                         U.S. Pop (mil)
       100

        50

         0
          1970    1980     1990      2000     2010

                                                           700

                                                           600

                                                           500

                                                           400
                                                                                                   U.K. Pop per sq mile
                                                           300                                     U.S. Pop per sq mile

                                                           200

                                                           100

                                                              0
Source: IMF WEBSITE - http://www.imf.org                        1970    1980  1990   2000   2010
http://www.stats.indiana.edu/maptools/maps/thematic/population/us_daytime_density
http://www.bestcountryreports.com/media/D_Images/UK_Pop.jpg
                                        Interest Rates

          18


          16


          14


          12


          10
                                                                     Interest Rates Federal Funds
                                                                     Overnight Rate
           8                                                         Interest Rates London Interbank
                                                                     Offered Rate (1 month)

           6


           4


           2


           0
            1975   1980   1985   1990    1995   2000   2005   2010

Source: www.federalreserve.gov
http://www.bba.org.uk -- British Banking Association
                    U.S./U.K. Demographics
                     Real Per Capita GDP
        45000


        40000


        35000


        30000


        25000
                                                                     UK Real PCGDP(£)

        20000                                                        US Real PCGDP ($)



        15000


        10000


         5000


            0
             1975   1980   1985   1990   1995   2000   2005   2010


Source: IMF WEBSITE - http://www.imf.org -- adjusted to real terms using
the IMF deflator
                                                                Combined U.S. Data
                          250                                                                                                 1000

                                                                                                                              900

                          200                                                                                                 800

                                                                                                                              700




                                                                                                                                     Population in Millions
Index or Interest Rate




                          150                                                                                                 600
                                                                                         Home Prices                          500

                          100                                                                                                 400

                                                                                                                              300
                                       Building Costs
                                                                                           Population
                           50                                                                                                 200

                                                                                                                              100
                                                                                                          Interest Rates
                             0                                                                                                 0
                              1880           1900          1920           1940           1960      1980      2000          2020
                                                                                  Year
                         Source: IrrationalExuberance.com – Robert Shiller’s Website
                             Real Home Prices




Source:
http://mysite.verizon.net/
vzeqrguz



                                                    Real House Prices                                                                                                               Trend
                             £210,000
                                                    Source: Nationwide Building Society
                             £190,000
                             £170,000               Base : 2008 Q4
                                                    Trend from 1975 Q1 to present
                             £150,000               Trend = c2.9% per annum
                             £130,000
                             £110,000
                              £90,000
                              £70,000
Source:                       £50,000

http://www.nationwide.co      £30,000
                                        1975 Q1

                                                  1977 Q1

                                                            1979 Q1

                                                                      1981 Q1

                                                                                1983 Q1

                                                                                          1985 Q1

                                                                                                    1987 Q1

                                                                                                              1989 Q1

                                                                                                                        1991 Q1

                                                                                                                                  1993 Q1

                                                                                                                                            1995 Q1

                                                                                                                                                      1997 Q1

                                                                                                                                                                1999 Q1

                                                                                                                                                                          2001 Q1

                                                                                                                                                                                     2003 Q1

                                                                                                                                                                                               2005 Q1

                                                                                                                                                                                                         2007 Q1
.uk/hpi/historical.htm
                         Irrational Exuberance

• “Irrational Exuberance” -- Alan Greenspan introduced
  the term to describe the behavior of stock market
  investors in 1996
• Robert Shiller -- Economics professor at Yale University
   – Irrational Exuberance, 1st Ed March 2000
   – Irrational Exuberance, 2nd Ed 2005
   – Co inventor of the S & P/Case-Shiller 20 city Home Price Index
• Irrational Exuberance defined:
   – “Wishful thinking on the part of investors that blinds us to the truth of our
     situation.”
                Irrational Exuberance

• How it creates speculative bubbles
   “News of price increase spurs investor
   enthusiasm, which spreads by
   psychological contagion from person to
   person, in the process amplifying stories
   that might justify the price increases and
   bringing a larger and larger class of
   investors, who, despite doubts about the
   real value of the investment, are drawn to it
   partly through envy of other’s successes
   and partly through gambler’s excitement”
                             Precipitating Factors

• 6 of Shiller’s 12 precipitating factors that
  propelled the recent market bubbles
  – Capitalist explosion and ownership society
  – Cultural emphasis on business success
  – New Information technology
  – Expansion of reporting of business news
  – Analysts optimistic forecasts
        • “It appears we have established a bottom.” NAR
          Chief Economist, January 2007
  – “New Era” thinking
  Source: Emily Friedlander “ ‘The Bottom is Here’: Former NAR Economist Lereah’s Rosy Statements”,
  Wall Street Journal, 11 Jan 2009
           Feedback Loop




                     Initial Price Increase




Increased Demand                              Investor thinks Price
 Bids up the Price                             will increase based
   Even Further                                on past experience




       More Investors join
                                   Bids up Speculative
      to avoid losing out on
                                      Price Further
            the profits
                      How It Ends

• Speculative Bubbles can be viewed as
  naturally occurring Ponzi Schemes
  – Speculative Bubble can’t grow forever
  – When investors no longer think prices will rise
    or new investors stop joining -- the bubble
    deflates or bursts
  – Downward Bubble may occur
    • Price Declines discourage some investors, causing
      further declines and so on.
                          U.S. and U.K. Home Prices

• No truly national (much less international)
  home price bubble until 1990s-2000s
• Increase in media coverage allowed
  communication of the story of increasing
  home prices and “new era” thinking
• International Real Estate (CDOs, REITs,
  etc) investing may have created
  international connections and incentives in
  the markets
Source: Glenn R Mueller; Vaneesha Boney; Andrew G Mueller “International Real Estate Volatility: A
Tactical Investment Strategy” Journal of Real Estate Portfolio Management; Oct-Dec 2008; 14, 4;
ABI/INFORM Global pg. 415
                             Real Home Prices




Source:
http://mysite.verizon.net/
vzeqrguz



                                                    Real House Prices                                                                                                               Trend
                             £210,000
                                                    Source: Nationwide Building Society
                             £190,000
                             £170,000               Base : 2008 Q4
                                                    Trend from 1975 Q1 to present
                             £150,000               Trend = c2.9% per annum
                             £130,000
                             £110,000
                              £90,000
                              £70,000
Source:                       £50,000

http://www.nationwide.co      £30,000
                                        1975 Q1

                                                  1977 Q1

                                                            1979 Q1

                                                                      1981 Q1

                                                                                1983 Q1

                                                                                          1985 Q1

                                                                                                    1987 Q1

                                                                                                              1989 Q1

                                                                                                                        1991 Q1

                                                                                                                                  1993 Q1

                                                                                                                                            1995 Q1

                                                                                                                                                      1997 Q1

                                                                                                                                                                1999 Q1

                                                                                                                                                                          2001 Q1

                                                                                                                                                                                     2003 Q1

                                                                                                                                                                                               2005 Q1

                                                                                                                                                                                                         2007 Q1
.uk/hpi/historical.htm
                          Questions?




“Whatever it is that drives this excitement, it
  can cross oceans”
  Robert Shiller, Irrational Exuberance, 2nd Ed, 2005
           Myth’s According to Shiller

• Stocks go down but will quickly go up
  again – Wrong
• Stocks outperform other assets – Wrong
• Mutual funds with good managers
  outperform – Wrong
• Houses are not that risky of an investment
  – Wrong
• Houses are the best investment --Wrong

				
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