Influential economist Robert Shiller believes the U.S. housing mess isn't the only asset bubble investors have to worry about in the coming months - the equity and commodity markets still have some more hot air to exhale, too.
The Yale University professor, best known as the author of the definitive market bubble treatise Irrational Exuberance, said yesterday that prices in both stocks and commodities remain unrealistically high, despite their recent losses. He added that a U.S. government bailout of the banking industry would be just a short-term fix for a residential mortgage system that stills requires a longer-term overhaul, and said Canada's housing market may not be immune to its own bust.
Still, he said, the credit crisis could be just the shock needed to kick-start sweeping changes in the financial system that could help break the vicious cycle of excessive investor risk-taking embedded in North American culture - the bastard child of the dot-com bubble of the 1990s that created unrealistic investor expectations that linger today.
"Financial innovation only comes in times of crisis," he said, pointing to the profound changes in the U.S. financial system that President Franklin D. Roosevelt instituted in his first 100 days in office in 1933. "We need to think of our financial institutions in a constructive and innovative way."
As an author, Mr. Shiller has proven himself extraordinarily prescient twice now. Irrational Exuberance landed in bookstores in 2000 just a month before the tech bubble began to burst. His latest book, Subprime Solution, launched on Sept. 1 - just ahead of an extraordinary month of subprime-fuelled upheaval in the financial sector.
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Posted on Thu Oct 02, 2008 at 11:53:12 PM EST
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In an interview after his address, Mr. Shiller said the stock market never completely rid itself of the bubble of the 1990s, and remains overvalued today.
"There's still exaggerated optimism for stock market returns," he said. "If it stays where it is, I think it's still somewhat on the high side."
Commodity markets also look overpriced, which is "probably related to the same bubble thinking that drove housing and stock markets," he said. "There's a sense of running out of everything that is pushing those prices up."
Mr. Shiller said the common argument in favour of a continued upward trajectory for commodity prices - the exponential growth in demand from China, India and other emerging markets as they rapidly modernize - is typical bubble thinking.
"We've heard those things before," he said. "Just 10 years ago, oil prices were somewhere in the order of 10 per cent of what they were recently, and China and India were growing rapidly then, too. The mere fact that China and India are growing rapidly is not reason to think that we're suddenly in a new era for commodity prices.
"But those arguments have a great emotional resonance. Bubbles are partly a cultural phenomenon - the price increases reinforce the tension to some oversimplified stories."
Mr. Shiller told the conference that Canada's housing market is exhibiting signs of its own bubble, and could be headed for its own bust.
"To me, it would be surprising if Canada didn't involve itself somewhat in the U.S. real estate bubble, and subsequent bust," he said.
But he said Canada's limited use of subprime mortgages should mean the fallout in this country will be much less severe than in the United States.
He said a U.S. government rescue of the banking industry is essential, to avoid the kind of long-term seize-up of lending that was a major contributor to the Great Depression.
But he called the bailout the "short-term" solution, which must be followed up by long-term changes in the residential mortgage system to better safeguard home buyers from overexposure to risk.
Source: David Parkinson From www.theglobeandmail.com 03/Oct/2008
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