Robert Shiller on Why So Many Experts Missed the Crash

In hindsight, the housing bubble and ensuing crash seem so obvious. Who could have missed it?

At the time, nearly everyone.

Despite the incredible leverage built up in financial institutions and blatant overbuilding in the housing market, the bubble and crash of 2008 surprised the majority of expert forecasters.

In an exclusive interview last month, I asked Yale economist Robert Shiller -- one of the few who warned of the housing bubble well before it burst -- where the economy is heading over the next 10 years. His response was essentially: No one knows. That moved into a conversation about why we're so bad at predicting what the economy and investments might do in the future. Here's what he had to say:

What do you think? Share your thoughts in the comment section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (20) | Recommend This Article (25)

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  • Report this Comment On January 17, 2012, at 9:29 PM, TomBooker wrote:

    "...it's not something you can quantify."

    Shiller is such a funny guy. And I mean that in the most respectful way.

    As one of the progenitors of a fairly well worshiped index, he is always the first person to warn against worshiping it. (And many others, for that matter)

    This really kills his interview/analyst-spot count with the titillating financial media. Yet, IMHO, it speaks volumes for his intellectual discipline and character.

    Great interview. EXCELLENT summary question.

    You popped an eyebrow on Dr Shiller.

    That is no simple task, Mr Housel.

  • Report this Comment On January 18, 2012, at 9:46 AM, wasmick wrote:

    "His response was essentially: No one knows....That moved into a conversation about why we're so bad at predicting what the economy and investments might do in the future."

    God, I hope he was self aware enough to include himself in this category (can't watch the video on this connection but would love to see a transcript).

    If calling something over and over until it finally happens is now prescience, count me in.

    It's gonna rain soon. Just you wait, I'm gonna be proved right.

  • Report this Comment On January 18, 2012, at 12:55 PM, DJDynamicNC wrote:

    ^^^ This is essentially my beef with the people who claim that Austrian economics predicted the recession.

    They've been predicting economic catastrophe since the removal of the gold standard (if not before), which makes them far more frequently wrong than right.

  • Report this Comment On January 18, 2012, at 9:08 PM, irvingfisher wrote:

    Galbraith wrote a nice little book on bubbles. Basically increasing asset prices combined with lots of leverage makes a bubble. When assets prices start to fall, loans are called and that starts more selling, resulting in vicious cycle of selling and falling prices.

    Not necessarily easy to spot, but anything substantially higher than historical prices can be a red flag.

  • Report this Comment On January 19, 2012, at 1:09 AM, IRunMan wrote:

    How many times must I say NO to the Motley Fool Pro advertisement. I've said no at least 4 times this round and I said no many times in the past. C'mon Fools......you are acting like fools. One no should be sufficient.

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  • Report this Comment On January 19, 2012, at 5:35 AM, GrandSupercycle wrote:

    Despite market intervention, long term equity charts (ie the big picture) are bearish and serious downside risk awaits.

    My long term indicators have continued to warn of USD strength and EURO weakness since 2009. The overdue dollar rally should be substantial.

    stockmarket618.wordpress.com

  • Report this Comment On January 19, 2012, at 3:17 PM, whereaminow wrote:

    ---->This is essentially my beef with the people who claim that Austrian economics predicted the recession.

    They've been predicting economic catastrophe since the removal of the gold standard (if not before), which makes them far more frequently wrong than right.<---

    That is simply an untrue statement with zero factual basis.

    They have a deductive theory that analyzes the steps (from boom to bust) of the cheap credit business cycle. That means, sometimes we'll be in a boom and sometimes we'll be in a bust. So it would seem rather silly for a School to promote such a theory and then bet against it half the time.

    I highly encourage people to learn the Austrian Business Cycle Theory, so you can move beyond the mindless drivel that makes up most modern day economics.

    David

  • Report this Comment On January 19, 2012, at 4:06 PM, talan123 wrote:

    I have read up on it but it still makes zero sense.

    They claim it's a theory but they discount all forms of evidence but their own deductive reasoning of their fellow humans beings, whom they consider irrational which kind of defeats the purpose of the theory.

    Therefore it's a theory based their beliefs which is not theory but a belief.

  • Report this Comment On January 19, 2012, at 5:11 PM, DJDynamicNC wrote:

    David, the earliest quote I could find from Ron Paul about economics was 1987, and it was every bit as apocalyptic as his quotes now.

    To his credit, an analysis of his investments shows he genuinely believes his own claims as he appears to be perparing for the complete collapse fo the US dollar, which is what he has also been predicting.

    I will concede that this is not from as far back as my initial claim and that I should not use him as purely representative of the entire Austrian movement.

    Re: business cycle - Elements of the Austrian Business Cycle theory have explanatory value and should be understood (for example, the effect of downward wage rigidity and inflated wages on unemployment, although I would argue that the emphasis on government regulation ignores perfectly normal market-based downward rigidity and handicaps the theory). That said, there are some serious flaws to it. For example, Rothbard said:

    "Successful entrepreneurs on the market will be precisely those, over the years, who are best equipped to make correct forecasts and use good judgment in analyzing market conditions. Under these conditions, it is absurd to suppose that the entire mass of entrepreneurs will make such errors, unless objective facts of the market are distorted over a considerable period of time. Such distortion will hobble the objective 'signals' of the market and mislead the great bulk of entrepreneurs.""

    In other words, entrepreneurs will be able to use good judgment and account for fluctuations in the market, but for some reason their good judgment is magically suspended if those fluctuations come from government policy, as though they will never be able to account for government policy and will suddenly lose sense of what's happening. No market exists in a vacuum, and anybody who can react successfully to technological advances should have no problem reacting to plodding government regulatory changes. And the presence of quantities of successful entrepreneurs would tend to back this claim up.

  • Report this Comment On January 19, 2012, at 5:28 PM, DJDynamicNC wrote:

    Also, what Talan said.

  • Report this Comment On January 19, 2012, at 5:38 PM, whereaminow wrote:

    ---> They claim it's a theory but they discount all forms of evidence but their own deductive reasoning of their fellow humans beings, whom they consider irrational which kind of defeats the purpose of the theory. <-----

    That sentence needs to be re-written. They don't consider humans irrational. They consider human action as rational when it has a means-ends framework.

    Obviously you didn't get very far in your study of ABCT. It's not very hard. Cheap credit causes malinvestment. The rest is in the details.

    David

  • Report this Comment On January 19, 2012, at 5:40 PM, whereaminow wrote:

    ---->but for some reason their good judgment is magically suspended if those fluctuations come from government policy<----

    Yeah, people always have a complete understanding of how government policy affects markets. That's why ALL of your neighbors were avoiding the housing bubble in 2004. I mean, heh, how stupid would they have to be to not see and completely understand all of the fluctuations caused by government policy.

    What idiots. And what an idiotic theory!

    David

  • Report this Comment On January 20, 2012, at 12:58 PM, jesterboomer wrote:

    Excellent interview and comments from Robert Shiller. Should you have another opportunity, I would love to hear what he thinks will happen to US debt in the longer term. Will the debt level as a % of GDP fade away through inflation or will there be an event where the Fed or treasury simply announce the creation of several $T to erase government debt - and what would be the ripple effect were that done.

  • Report this Comment On January 20, 2012, at 2:58 PM, TMFGortok wrote:

    Ron Paul and other Austrian economists saw it coming (of course, since they aren't part of the mainstream Keynesian economist-academic circle, it doesn't count, right?):

    ---

    From Ron Paul's July 16, 2002 speech on the House floor:

    Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

    However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

    Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

    ----

    Another well-known Austrian economist, Peter Schiff, also forecasted the bust -- and at the time, he was practically laughed out of the news segment by the Keynesian talking head next to him:

    http://www.youtube.com/watch?v=tZaHNeNgrcI

    It's time to stop trusting Keynesian economics.

  • Report this Comment On January 20, 2012, at 3:35 PM, DJDynamicNC wrote:

    -->Yeah, people always have a complete understanding of how government policy affects markets.<--

    That was not the claim I made at all. You also failed to address my point entirely.

    To reiterate: if, as Austrian economics predicts, entrepreneurs are capable of understanding and adapting to the vagaries of the market - not perfectly, but well enough to succeed and even thrive - then why are they not similarly endowed when it comes to government policy?

    This is a very important point that would undermine the entire thesis of Austrian economics and praxeology, and rather than address it you settled for knocking down a strawman.

    I can't imagine you're not capable of addressing so fundamental a point, so I'm not just asking to be a jerk, I'm genuinely curious how you square that.

  • Report this Comment On January 20, 2012, at 3:44 PM, DJDynamicNC wrote:

    @TMFGortok - Austrians are far from the only ones who saw it coming (see Minsky, Hyman).

    "Easy credit leads to bubbles" is a claim often associated with Austrian economics, and it's a claim I find quite plausible. And I think the government subsidies designed to incentivize housing purchases are flawed and should be done away with or modified.

    Nothing about those claims is inconsistent with, or invalidates, Keynesian economic policy.

  • Report this Comment On January 20, 2012, at 7:42 PM, talan123 wrote:

    Peter Schiff has been saying the dollar is going to collapse and massive inflation is going to happen since 2002. That's ten years of being wrong.

    "At the time of this 2002 interview, the U.S. stock market had already suffered steep losses and the economy was in recession. The highlights of Schiff's predictions: he saw substantial downside over the next couple of years for the stock market. He predicted that the Dow, which was around 10,000 at the time, would plummet to between 2,000 and 4,000 and he even went so far as to say that the Dow might fall below 2,000. He expected the NASDAQ to drop to 500 from its then level of 1,700. He also said that the dollar was going to fall sharply and interest rates were going to go through the roof accompanied by dramatic inflation. "

  • Report this Comment On January 20, 2012, at 10:57 PM, maxbigbucks wrote:

    You heard it here from me: within 8-15 years, barring collision with a large astronomical body, a widespread nuclear conflict, or the re-introduction of antibiotic resistant bubonic plague, there will be a worldwide economic expansion and resurgence of credit that many will think will go on forever, and which will absolutely be guaranteed to be followed by the falling of the sky and an economic bust that many will think will go on forever. I know this because I am both a genius with a 200+ IQ, profoundly psychic, and have read lightly in the economic history of the capitalist system of production, starting with, but not limited to "The Condition of the Working Class in England". Boom-Bust-Boom is the name of the game, silly. The Bank guys and their friends on the exchanges, traders, regulators, derivative bundlers and similar rich scoundrels with corner offices on the top floor all knew by as early as 2002 that the Emperor's outfits were getting thinner and more transparent with each passing year. With their IQ's of 220+ and deep understanding of Capitalist Economic History and quasi criminal moral underpinnings, they were canny enough to not even whisper what they knew was inevitable, until the very end, that the music was about to stop and to look fast for a seat because they all, with a few exceptions (poor Lehman) were getting incredibly and outlandishly rich at the expense of the Fools. They knew and kept it all quiet as they triumphantly marched to their vault rooms loudly announcing that they had no idea...

  • Report this Comment On January 23, 2012, at 2:07 PM, DJDynamicNC wrote:

    @Talan - can you link me the source of that quote? I'm interested in reading the whole article.

    Thanks!

  • Report this Comment On January 23, 2012, at 8:11 PM, umh wrote:

    Predicting something is fairly easy; knowing when your prediction will happen is the tricky part.

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