Filed under: Housing

Robert J. Shiller’s Irrational Exuberance is the classic book for understanding the stock market bubble of the late 1990s and early 2000s. His contribution to the study of real estate is equally compelling. The House Price Index used to track our real estate market was co-developed by Mr. Shiller — and is innovative in that it adjusts for the quality of homes involved in transactions.

So given his expertise in bubbles and real estate, he is probably the guy to listen to when it comes to the topic of the real estate bubble.

In a column in this Sunday’s New York Times, Shiller gives an interesting possible explanation for a question that hasn’t gotten a lot of attention: Why were Alan Greenspan — and a lot of other presumably intelligent people — unable to see that real estate bubble for what it was given that, in retrospect, it seems so obvious?

The answer may lie in a psychological phenomenon known as information cascade. Be sure to read Shiller’s column for an explanation of how this may have applied to the real estate market. It’s fascinating stuff.

And understanding why the bubble wasn’t widely detectable is key to understanding why it happened. As Shiller writes, “The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.”

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This entry was posted on Monday, March 3rd, 2008 at 5:03 am and is filed under Stocks Money News. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.