Boom... Bust! What's Next for the Ottawa Housing Market?

Shiller was soon convinced of what most informed people now believe; that U.S. investors created a stock bubble in the 1990s before causing a housing bubble in the 2000s. A bubble, as Watson defines it, is a run-up in prices going beyond anything that reasonable economic calculation can justify.

He goes on to say:

If high-tech firms had made unprecedented profits and paid out unprecedented dividends, maybe unprecedented stock prices would have been justified. But they didn't. If the cost of building new houses had doubled over the last 10 years, maybe it would have made sense for the price of old homes to double, too, but it didn't.

How could so many normally rational investors become addicted to irrational speculation? Shiller describes the causes as social contagion and information cascades. Once a bubble forms, says Watson, "all that people hear about is how the boomers are aging, new technologies have created new paradigms, China and India change things forever, this time it's different." The bubble bursts when enough strong-minded investors decide the fantasy is simply too ridiculous to be believable. Smart players leave the game early. All the others lose.

But here, apparently, is where Watson finds all the bad news encouraging. "If social contagion and information cascades can carry us all off to manic highs, presumably they can also drive us down to unwarranted lows."

Although there are plenty of reasons why Canadian, U.S. and world economies will under-perform in 2009, bad news from media and politicians and other doomsdayers need not convince us that we are returning to the bad old days of the 1929 Depression.

Says Watson, "We're quickly talking ourselves into depression. We've gone from the subprime to the ridiculous, you might say."

According to Watson, a crumpled bubble is no more reasonable or justified than the inflated bubble was. It too might turn around just as quickly.

The wired world we boomers and our offspring have built is famous for its volatility and short attention span. It was just six months ago, remember, that 'this time it was different' and $150 a barrel was the new floor price for oil. Now people are thinking we'll see $20 oil again.

He reminds us that our TV civilization can't hold a reasonable train of thought for more than a few months at a time. And "a few good pieces of economic news might dispel the irrational despond we're currently living through."

Reading Shiller made Watson optimistic. Shiller is convinced that "the new financial technologies that have such a bad name right now will make us all much better off in the long run". In particular, he's working on "ways ordinary folk can get out from under the now standard but truly bizarre investment custom in which most of us sink most of our net worth into a single piece of real estate."

Two recent suicides by multi-millionaires who lost all their wealth by investing everything they owned in one stock, or one allegedly fraudulent fund, emphasizes just how irrational speculators or gamblers can be when motivated by greed!

What he suggests is establishing a derivatives market for housing "in which payouts are keyed to the Case-Shiller house price index." That, he and Watson maintain, would avoid a replay of the housing bubble in another twenty years time.

We are inclined to be more skeptical, since it is derivatives and hedge funds and subprime mortgages which no one appears to understand, that got the stock markets into trouble in the first place. The stock market was defined in the seventeenth century by Joseph de la Vega, after all, as "a touchstone for the intelligent and a tombstone for the audacious."

source: the Montreal Gazette