Planet Money - What's A Bubble? (Classic)

Episode Date: July 1, 2021

Can you tell if the economy is in a bubble? How? And why do bubbles happen? Robert Shiller and Eugene Fama shared the economics Nobel back in 2013 despite fundamentally disagreeing over the meaning of a bubble. | Subscribe to our weekly newsletter here.Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is Planet Money from NPR. The U.S. stock market hit a record high this week. Home prices are going through the roof. And I'm not saying that we're in a stock market bubble or in a housing bubble. I'm not saying that prices are absurdly high and are inevitably bound to come crashing down. But it does seem like a good time to run a show that we did back in 2013 when two economists, Eugene Fama and Robert Shiller, won the Nobel Prize in Economics for their work on bubbles. These two economists were really a pretty unlikely pair to share the prize

because intellectually, they kind of come from different universes. When people heard their names announced together, people said, really? Schiller and Fama? Schiller himself had a similar reaction. That was a complete surprise. I hadn't thought that that would happen. He and I seem to have very different views. It's like we're different religions, you know? It's just certain assumptions, basic assumptions are different. Hello and welcome to Planet Money. Today on the show, a philosophical question. Are we ruled by our heads or by our hearts? Are we logical creatures responding rationally to rewards and punishments? Or are we dreamers falling in love

and making terrible mistakes with money? In a minute, we will have the 2013 conversation that Planet Money's Robert Smith and David Kestenbaum had with Eugene Fama and Robert Schiller, two men whose disagreements have shaped the way we think about bubbles. The word bubble drives me nuts, frankly. This is Eugene Fama, the man who believes the world is rational. And if you believe in a rational world, then the whole concept of bubbles doesn't make any sense. Because the price is always right. It reflects the collective wisdom of everyone in the market. Yes, prices go up, sometimes way up, and sometimes they come down quickly. They crash. But it doesn't mean

the prices were wrong. It doesn't mean the markets went crazy. Fama's view is that prices change when people get new information. In fact, that's part of what he won the Nobel Prize for, showing that stock prices quickly react to news. That's why the word bubble drives him crazy. Fama says no one even has a good definition of this bubble thing. Yes, and here's where I differ from Fama in some fundamental ways. It's Robert Schiller, the one from Yale. He says he doesn't even know what a bubble is

and thinks that no one has properly defined it. Actually, I really respect the man. I think that in a way he's right. It wasn't really carefully defined. So I wrote my own definition of it in the second edition of my book, Irrational Exuberance. Let's hear it. Well, I give kind of a long-winded definition. It's like a mental illness. If you look at the American Psychiatric Association's Diagnostic and Statistical Manual, which defines mental illnesses, the mental illness definitions consist of a checklist of symptoms. Okay, so let's go through this Schiller checklist of symptoms you may be experiencing if you are living through a bubble, and we'll see how it applies to the most recent housing boom. Okay. Bubble, first of all, he says,

a bubble is a time of rapidly increasing prices. Check. Home prices in Miami basically doubled in a few years. Okay. He says people tell each other stories that purport to justify the reasons for the bubble. Check. I have a book at my desk from this very time period. The title is Why the Real Estate Boom Will Not Bust. Best seller. People tell each other stories about how much money they're making in a bubble. Check.

The subtitle of the book is And How You Can Profit From It. And, of course, there is the time when people feel envy and regret that they, too, did not participate in said bubble. Check. I did. Schiller says it's like a social epidemic. There's an impulse to buy into it because of the swirl of emotions that one feels. And it trumps your common sense. Oh, I would add one more. First of all, the news media are involved.

Thanks a lot for that. Well, there were no bubbles before there were news media. The first famous bubble was the tulip mania, and Holland was the publishing capital of the world then. There were newspapers, there were broadsides, there were pamphlets, And I think that's necessary. Now, Schiller says that this pop psychology definition of bubbles, this used to be heresy in the economics field, but it's not anymore. Yeah, I used to feel embarrassed to say the word bubble. It's like showing up at an astronomy seminar and talking about astrology. You know, you don't get a good reception. I went through finance textbooks and looked, is the word bubble in the textbook? This is like 20 years ago. Absolutely not.

That's just rubbish. Don't ever say that around here. Now it's in a textbook. Now it's back into the textbooks. Yeah. Okay. So that's Schiller's definition of a bubble. Eugene Fama's response is, so what? Lots of things that meet that definition don't crash. Here, this one's my example, not his, but look at Google, right? It had a rapid run-up in price. Check. Over the last nine years, Google's gone up more than 1,000%. Stories people tell to justify the high price. Check. The people at Google are geniuses. Lots of emotions, envy, regret.

It used to be $85 a share, $85 a share, and now it is over $1,000 a share. Kills me. So is Google in a bubble? If it crashes, people will say it was a bubble. But we're asking now. Fama says if you think something's a bubble, you are basically predicting that it will end, as bubbles always end, in a spectacular crash. And he doesn't think anyone can do that kind of prediction reliably.

Because I don't think there's anything in the statistical evidence that says anybody can reliably predict when prices go down. So if you interpret the word bubble to mean I can predict when prices are going to go down, you can't do it. Explain why. I believe markets work. And if markets work, those things shouldn't be predictable. If I can predict that housing prices will go down, if the market's working properly, they should go down now. Why? Because what you're saying is, I have information that prices will go down, and that information is not in the prices. If the market's working properly, the information should be in the prices. Because the people who believe it will go down would buy or sell something. They won't buy the house, right.

If they think the prices are going down, they won't buy the house. So Eugene Fama, Nobel Laureate in Economics, says bubbles don't exist. After the break, we will hear a very different point of view from Robert Schiller, also Nobel Laureate in Economics. So, Fama argues that the bubble definition makes no sense because you cannot use it to predict you are in one. And then Schiller says you can. Maybe not predict the actual date that a bubble is going to burst and a stock market will crash,

but you can tell it's coming. You can have a fairly high degree of confidence. That's what I felt in the stock market in the late 1990s. I wrote the first edition of my book, Irrational Exuberance, then because I was rushing to get it out. I told my publisher, Princeton, please get this out because I want this book out before the crash, not after.

And then again, I felt that in the 2000s with the housing bubble. Now, we should make this very clear. Schiller was on the record for these two events. He said there was a bubble in stocks in the 1990s. He said there was a bubble in housing in the 2000s. And he was right. All right, I'll take up Fama's side here. Fama's response is that he's looked at a lot of data of people trying to predict the stock market. And he says there is very little evidence that anyone is any good at it. Sure, some people seem to make a killing, but for the most part, he says, that can be explained by just dumb luck. There are millions of people out there making predictions, buying and selling stocks. Some of them will happen to pick the ones that go up, and they'll look like geniuses afterward.

That's basically how he feels about people who say they can predict bubbles. So what happens each time is the media goes in and finds somebody who predicted it. That person gets anointed. You don't go back and look at past predictions and see, is this just luck? So was Schiller one of those people who was anointed by the media? Oh, yes. Because he happened to be right about this one, you would say. Right. Well, he and other people, there were others. You know, people have done experiments in the lab where they can create bubbles from sort of psychology, people feeding on each other and getting whipped up in a frenzy. Right. What does that prove? Why do you find it so hard to believe that that might happen in the real world?

Oh, you use the key word, believe. I'm not a believer. I'm an empiricist. What would prove it to you that there were bubbles? Empirical evidence. Such as? Well, that you could show me that you can predict when these things turn in some reliable way. So what is your challenge to Robert Shiller? He should predict the next bubble.

Right. Well, I don't know. Not just the next one. You know, statistical reliability means more than two, really. The next 10? Well, the next 10 would be really convincing. Yeah, then I'd be convinced. This is it, David.

We have a way to solve this debate. Finally, the gauntlet has been thrown down, and we presented the challenge to Professor Robert Schiller. Fama said he would believe there were bubbles if you could predict 10 of them in a row. Yeah, but I don't live that long. You know, these big bubbles are rare events that play out over years. They can go a long time.

If you lived long enough, do you think you could make good on Gene Fama's request that you predict 10 bubbles in a row? If I lived long enough, yeah. You do think you could? I think so. But, yeah, I'm not the most self-confident person. Robert Schiller and Gene Fama told us they agree on the facts that the other has uncovered.

They just don't agree on the interpretation. But to me, that seems like a big deal. Interpretation here is everything. If you think bubbles are predictable and due to crazy psychology, that suggests that something can be done to stop or to prevent them. If, on the other hand, you think bubbles are really hard or impossible to predict, well, then there's not much you can do. And this is where the economics Nobel differs from, say, physics or something,

because you don't get the science prizes until everyone pretty much agrees on the topic. It's a done deal. Peter Higgs won the Nobel Prize in physics this year because they discovered the particle he predicted, the Higgs boson. Boson. Boson. Discoveries like that, I think, are harder to come by in economics. That's just the way it is. I mean, economics is more of like an evolving argument. Even in the press release, the Nobel

Committee, they applaud these two men for doing work that, in their words, is surprising and contradictory. And, you know, talking to Schiller and Fama, I mean, they clearly have a love for this aspect of economics. They have a love of the argument, and they didn't seem terribly alarmed that two different worldviews will have to share the same prize. Schiller says it's kind of what he signed on for. There's something inherently difficult about economics. Partly you can't run a controlled experiment. You can't replicate circumstances. Everything is changing all the time. I think we're doing pretty well given the difficulty of the subject matter. Schiller's co-laureate Gene Fama says the Nobel Prize has accomplished one thing at least. It's got people talking about this question. Well, this is the first time anybody from NPR

ever contacted me to do an interview, so we're talking 50 years here. People all of a sudden are interested in what you think and say, and you haven't really changed, so you wonder what it's all about. Robert, you know, I told Vama that I actually did interview him several years ago, but then after we got off with him, I went and looked up the story.

And it turns out I did not use any tape from him in the story. So he wasn't actually on the radio. Sorry. That was David Kestenbaum and Robert Smith speaking to Nobel laureates Eugene Fama and Robert Schiller. This episode originally aired in 2013. Today's rerun was produced by Darius Rafian and engineered by Gilly Moon. The supervising producer for Planet Money is Alex Goldmark. You can email us at planetmoney at npr.org. You can also find us on many of the social media. We are at Planet Money. If you haven't checked out Planet Money TikTok yet,

you should. It's strange and smart and great. I'm Jacob Goldstein. This is NPR. Thanks for listening. And a special thanks to our funder, the Alfred P. Sloan Foundation, for helping to support this podcast.