After analyzing the causes of the
hosing price rise, Shiller proceeds to tackle the perception of constantly
rising home prices. He takes on the commonly held view that with limited land
and constant rise in GDP and consumption, the housing prices will rise. He
counters this with the ideology of abundance of resources available for constructing
the houses like lumber, glass etc. and the fact that with depletion of
resources, humans have always found suitable substitutes. He points out that
the increasing incomes have been spent on the amounts of housing and not in
home prices. He also mentions that the rise in housing quality has contributed
to the price rise. It is the inability of the people to comprehend these
factors that has led to speculation which in turn has pushed up the house

Shiller then moves on to find the
reasons behind the rise in house price. He attributes the price rise to
over-optimism that was prevailing during the growth of the bubble. In contrast
Alan Greenspan, the then Federal Reserve chairman, was singling out the
simplicity of econometric models and lack of data whereas, in reality, the
psychological and sociological factors, which the existing models did not
consider, were overlooked. Shiller claims that the Federal Bank cutting down
the rate of interest was not the ‘exogenous’ cause of this housing bubble but
rather the effect of the stock market bubble bursting, which also caused the
housing bubble. He refers to the period in 1999 when the prices of houses were
increasing even though the Federal Bank had increased the rates and mentions
that the period of low rates was only one third the period of the housing
boom.  However, he does agree that this
reduction in the federal rate played into the hands of the housing bubble.
Additionally, this optimism fed back into the bubble thereby increasing its
size with the progression of time. Shiller also attributes the crisis to poor
regulation that failed to prevent the aggressive subprime lending.  Here, Shiller recounts two anecdotes
regarding the subprime lending wherein the bank regulators didn’t stop the
lending of mortgages and Freddie Mac had not tested a huge drop in the housing
prices. Shiller concludes that these responsible authorities, instead of acting
on the data were also speculative if not to the extent of common people and
that led to the increase in the size of the bubble. With this, Shiller proceeds
to examine how this bubble of rising house prices happened. From history, he
derives that speculations have always led to increase in prices of land. In
fact, the contribution of land to the value of the house had risen from 15% to
50% over time. Shiller, co-created an index that records housing price over
time and found that there was a constant rise in the house prices and those who
invested in the real estate sector found profits and this profits then fed back
into the bubble.

From personal experience, Shiller
recounts that there was a lack of continuous data of house prices and that no
one bothered to look back at the historical trends in house prices for
comparison and analysis. He found data scattered and accumulated over short
periods of time. Thus, using the available data, he created an index that
represents the price of houses from 1890 till 2004. Here, with the help of
various figures, the author represents the changes in house prices across
various tiers, cities, and countries. The key finding from these figures was the
disproportionate rise in ratio of house price to construction costs. Further, the
prevalence of these conditions across countries led to the conclusion that
these conditions were created by psychological factors across different markets.

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Robert Shiller calls the
financial crisis that began to unfold in 2006 ‘subprime crisis’. He says that
it affected the trust and optimism amongst the people and draws a parallel with
the situation post World War I wherein the Allies assigned the blame for the
war and hence reparations on Germany. He blames the overpromotion of
homeownership and the inability to deal with such speculative bubbles as the
reason for the crisis and calls for reforms within the financial system to
prevent the growth of such bubbles, which in this case had also transferred to
other sectors and countries. Shiller proposes risk management and institutional
framework as solutions to deal with such a problem rather than returning to the
old system. He then goes on to compare the bursting of this bubble and the
response on both the private and government fronts in the aftermath with the
previous housing crisis of such magnitude, which was during the great
depression. He cites the examples of organizations such as The National
Association of Real Estate Boards, Federal Housing Administration, Securities
and Exchange Commission that were created in response to the housing crisis in
the 1930s to underline the importance of those measures and how the measures
taken in response to the subprime crisis were inadequate. Thus, Shiller
proposes short-term and long-term solutions that, he feels, would help prevent
such crises in the future. These solutions form the crux of the book.


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