Friday, March 11, 2005

The Economy | Birthday, Shiller and bad bubbles

Inquirer Columnist

So how did you celebrate the bubble's fifth anniversary?

Did you raise a glass to the dot-coms of yesteryear? Sing "Auld Lang Syne" for the money you lost? Or simply observe a moment of wistful silence for those dear, departed days of irrational exuberance?

It was, of course, on March 10, 2000, that the Nasdaq hit its all-time high of 5,048.62, marking the apogee of Wall Street's 1990s moon shot.

Me, I marked the day by rummaging through old columns, looking to see if anything I wrote back then would justify a big, fat 'I told you so' five years later.

Alas, no such luck. I was as clueless as anyone else that the market had peaked. My March 10 column was about - what else? - Social Security.

On the other hand, I did convey a warning of sorts three weeks later.

Yale professor Robert Shiller had just published a book, titled - with what now seems amazing prescience - Irrational Exuberance. Shiller, I reported, believed Wall Street had effectively lost its marbles.

He wasn't exactly predicting a crash. But he did say it was reasonable to expect the Dow Jones industrial average - which peaked at 11,726 in January of 2000 - to be shuffling around the same level in 2020.

At the time, that forecast seemed unbelievable, almost shocking. From 1995 on, we had grown accustomed to seeing the Dow break past 1,000-point barriers on a regular basis.

How high the Dow?

Stocks had risen above all expectations - all rational ones, at any rate - inspiring market gurus to make increasingly fantastic predictions.

A book appeared titled Dow 36,000 followed by another called Dow 40,000 and then one called Dow 100,000. The sky was the limit.

But Shiller wasn't buying it. The "new economy" existed mainly in investors' heads, he said. When the web of delusion began to fray, we would learn just how much support - or how little - really existed for high stock prices.

Fast-forward to 2005. The Nasdaq went from more than 5,000 to less than 1,200, losing 78 percent of its value before recovering to today's 2,055. The Dow dropped less radically - to 7,386 - and today is at 10,851.51.

So a quarter of the way to Shiller's 2020 forecast horizon, you can't say he's wrong so far. And here's an update: Shiller thinks stocks are still pricey.

"The market is down significantly, but is still very high by historical standards," he wrote in the newly published second edition of Irrational Exuberance.

You don't hear much bubble talk anymore on the likes of CNBC, Shiller said, but "deep down, people know that the market is still highly priced, and they are uncomfortable about this fact."

Next up was real estate

That's not all. After stocks crested in 2000, Americans transferred their irrational exuberance to real estate, Shiller believes. "I think the real estate bubble is a transformation of the stock market bubble, and it's very much alive right now," he told me.

It certainly looks that way in the charts. Adjusted for inflation, home prices for the nation as a whole stayed roughly flat from the late 1940s until the late 1990s. Since then, they have shot up more than 50 percent.

Real estate brokers and other polyannas claim it's all justified because population is growing, because land is getting scarce, or because interest rates will stay low forever.

Shiller isn't buying it.

True, the real estate market is different from the stock market. Most houses are not bought for speculation, but to live in. Masses of people aren't likely to rush to dump their houses, the way investors scrambled to unload AOL or Cisco shares in 2000 and 2001.

But home prices still can fall - for the same basic reasons stock prices fell: People cease to believe in them.

Shiller isn't forecasting disaster, in either stocks or real estate. He's just saying bubbles happen, and we need to understand and prepare for them.

And even after five eventful years, he doubts there has been much progress on that score. "There's a real difference in emotions" since 2000, Shiller told me. But he added, "I don't know if people have learned a whole lot."


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