Robert Shiller Sees More Housing Pain Ahead

The Yale economist who called the housing bubble says foreclosure-gate is sapping confidence and more home price declines are likely.

When it comes to calling bubbles, Yale professor Robert Shiller has a pretty good track record. He raised a red flag about Internet stocks just before the market crashed in 2000, and he called the housing bubble in 2006 -- again, just before prices tumbled. Now the co-creator of the S&P/Case-Shiller Home Price index says the foreclosure crisis is another chapter in the story of mistrust of financial institutions that was ushered in with the financial crisis and the recession. And with so little confidence in the housing market, he says, prices have further to fall. In an interview with Kiplinger, Shiller shares his views on how foreclosure-gate could lead to another bailout, why the housing market won’t recover in 2011, and why he sees a good chance of a double-dip recession.

KIPLINGER: How much of an issue is the foreclosure fiasco for the recovery of the housing market and the economy? Does this go beyond a paper-processing problem?

SHILLER: It’s another hit to our public sense of trust and confidence in our financial institutions. Business relies on trust, and if you can’t trust anyone, you can’t do business very well. That’s a very different kind of confidence than is measured by the standard indices. But I think it’s very important for the economy.

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How much of an effect will foreclosure-gate have on home prices? Home prices were declining for almost three years, from 2006 to 2009. Then they picked up remarkably. But the pickup corresponded to the home-buyer’s tax credit. So it doesn’t look as if there’s a clear indication of change in home-buyer sentiment. The latest S&P/Case-Shiller data shows that home prices are flat again. Based on those numbers, I would be concerned about the possibility of a longer-term decline in home prices.

I think this is more important than foreclosure-gate. If home prices drop further, homeowners will fall further underwater and lending institutions’ balance sheets will become more distressed. That could bring on another phase of the crisis.

So you aren’t optimistic that home prices will recover in 2011? My company, MacroMarkets, does a survey of professional forecasters, and the survey has been weakening in recent months. We ask them to forecast as far out as 2014. On average, they’re now predicting a cumulative home-price increase of about 8% from today out to 2014, or about 2% a year. That’s a modest recovery. If their forecast turns out to be right, that might be enough to propel the construction industry out of the extreme doldrums. But it doesn’t seem like it’s enough to bring back a vibrant market.

You might think that it’s about time for the housing market to recover because it’s been at historically low levels in terms of new construction for quite some time now. But it’s not showing signs of that yet. So I think there’s a good chance that we’ll have a weak housing market next year. Unfortunately, there’s a good chance we’ll see declining prices over the next year.

What if banks end up having to buy back bad mortgages? How will this affect the financial system? Well, they might need another bailout. The problem is that public opinion was kind of negative about bailouts. I think it’s fortunate that both political parties were involved with the TARP bailouts. So it’s not a partisan issue, I hope.

Do you think Congress should intervene to help fix the housing market? They should take some action. The fact that so many people are in foreclosure is a national tragedy. In the future, we should build mortgages with built-in workouts [mortgages that allow greater flexibility to avoid foreclosure by adjusting payments when the borrower is experiencing financial hardship]. Our failure to do workouts this time was a colossal error. We should be thinking about other kinds of mortgages that are not so vulnerable to this kind of crisis.

We created a situation that caused a recession that wiped out the net worth of about 15 million households. That’s a mistake. Many of these people have virtually no other savings. So there was something wrong with the system.

Do you still maintain the view that there is more than a 50% chance that the U.S. slips back into recession? I still stand by the view that there’s more than a 50% chance we’ll slip back into a recession before we recover from this one -- before unemployment is back down to a normal level. I don’t know that it will be in 2011. I just think that the unemployment rate is going to stay high for a long time, and recessions come with some regularity. The economy is not looking particularly strong now, so it could come soon.

Jennifer Schonberger
Staff Writer, Kiplinger's Personal Finance