The Joe Walker Podcast - Markets And The Madness Of Crowds - Robert Shiller

Episode Date: September 7, 2019

Robert J. Shiller is Sterling Professor of Economics at Yale University and one of the 2013 recipients of...See omnystudio.com/listener for privacy information.

You're listening to the Jolly Swagman podcast. Here's your host, Joe Walker. Hello there, ladies and gentlemen, boys and girls, swagmen and swagettes. Welcome back to the show. I'm thrilled to be able to share with you this two-hour conversation with Robert or Bob Schiller. Let me briefly introduce him and then highlight some of the topics we speak about before throwing to the conversation. Bob won the 2013 Nobel Prize in Economic Sciences, which he shared with Eugene Farmer and Lars Peter Hansen. Bob is Professor of Economics at Yale University and the co-creator of the Case-Schiller Index of US House Prices. He's author of multiple

books, including the bestseller Irrational Exuberance, the third edition of which was published in 2015. Now, with or without his Nobel Prize, Bob is a special economist. And to understand why he's special, you have to understand two charts. I'll put links to them on my website. The first chart concerns the stock market. On the 3rd of December 1996, at a lunch along a long table in a dining room at the Federal Reserve, Bob, then a little-known Yale economist, distributed a version of this chart to those present. It displayed the long-term price-to- earnings ratio for the S&P 500 going back to the late 1800s. This long-term ratio was devised by Bob and a student of his, John Campbell, in 1988, and provided a means of gauging whether individual stocks, or in this case the aggregate stock market,

were fairly valued. Bob believed it to be more accurate than short-term ratios because it smoothed out fluctuations. It was taken by dividing a company's stock price at any point in time Bob believed it to be more accurate than short-term ratios because it smoothed out fluctuations. It was taken by dividing a company's stock price at any point in time by its average earnings for the past decade. So, if its stock was selling at $30 per share, and its average earnings over the previous 10 years had been $2 per share, its long-term price-to-earnings ratio was 15. The chart Bob passed around at the end of 1996 showed that the long-term price-to-earnings ratio for the S&P 500 was above 25, higher than it had been at any time since the end of the roaring 1920s. At this point in the meeting, Bob personally warned then Fed Chairman Alan Greenspan that the stock market had reached irrational levels. He asked Greenspan when was the last time that a Fed Chairman had warned the public that the stock

market had become a bubble. Greenspan was characteristically inscrutable, but two days later gave his famous irrational exuberance speech. Markets around the world swooned, but quickly resumed their march upwards. We now look back on this period as the tech stocks or dot-com bubble. It would be the greatest bull market in history. By early 2000, Bob's ratio peaked at 43. A few weeks later, the first edition of his book, Irrational Exuberance, borrowing for its title the phrase he'd inspired Greenspan to utter three years earlier, hit the shelves. It contained an updated version of the chart and another warning. Bob's claim that the market was in a bubble and might collapse registered as faintly offensive to many economists and Wall Street analysts.

He recalls feeling vaguely shunned at the time. Yet he was right, and the rest was history. In 2005, the second edition of Irrational Exuberance was published. By now, Bob had added a new chapter and a second chart about the unusually rapid appreciation in house prices, not just those in America, but also around the globe. The second chart plotted four lines, real home prices, long-term interest rates, construction costs, and the US population. What it showed was striking to anyone with or without an economics degree. Beginning in 1998, US house prices shot into the heavens without any commensurate changes in fundamentals. Bob had already begun talking about a housing bubble, but in 2005, his predictions became sharper. He warned publicly

that real house prices could fall 40% over the coming generation, and the bursting of the housing bubble would, in all likelihood, cause a recession. As with his stock market prediction, it's easy to forget just how radical a position this was at the time, especially for a self-respecting Yale professor. It didn't make Bob many friends. Serious investors and analysts were saying home prices could never fall. Bob was nicknamed Mr. Bubble and Dr. Doom. He became a bette noire of Wall Street and the real estate industry. In a 2005 interview with David Leinhart, Robert Toll, the chief executive of Toll Brothers,

a large high-end home builder, brought up Bob's name without even having been asked. Schiller is predicting the mountain goes into the sea, Toll said. He's selling himself. Once again, the rest was history. Bob is a hero of mine, and not just because of his intellectual confidence, belied as it is by an affable, softly spoken Midwestern accent, I also admire him because he embodies two sets of seemingly contradictory traits. For one, in seeking to understand markets, Bob is a master of mathematical modelling, but sees psychology and sociology as essential. And two, although he's an academic by trade, he's also an entrepreneur. For example, he once mortgaged his own house to fund one of his startup companies and he's a financial policy problem solver and on that practical note I heartily recommend his book Subprime Solution published in 2008. In this conversation Bob and

I speak about speculative bubbles and towards the end we speak about Australia's housing market which many people including me consider to be an example of a bubble. We also speak about Australia's housing market, which many people, including me, consider to be an example of a bubble. We also speak about economic narratives, the stories that people tell each other and buy into, and how they can be not just the symptom, but the cause of economic events. In this view, narratives are the data for economists to model and analyse.

We discuss, for example, how the trouble in Hong Kong might breathe new life into the Australian housing market, because even if the liquidity escaping Hong Kong and finding its way into Australian properties is ultimately inconsequential, the stories people will tell about how it drives prices might in and of themselves provide rationalizations for greater domestic demand. Between recording this episode on the 31st of August and releasing it on the 7th of September, Carrie Lam announced her intention to withdraw the controversial extradition bill, which sparked the Hong Kong protests. But given the withdrawal is just one of five demands of the protesters, I think it's safe to say the situation is not fully resolved and remains unstable. Indeed, the wounds that have been opened up between the CCP and the Hong Kong people may have left irreparable scars. As Hong Kong pro-democracy activist Joshua Wong said on Twitter, Carrie Lam's response was too little and too late. He also said the protests will continue until the day we have free elections. And indeed, the day after Lam's

announcement, schoolchildren were protesting, chanting five key demands, not one less. Now, whether you believe me or not that the trouble in Hong Kong is continuing, you can see what I'm doing here. I'm spinning a narrative. One final thing before I throw to the interview. Bob and I speak about the availability and representativeness heuristics, two mental shortcuts which can result in biases and which were proposed by the psychologists Amos Tversky and Daniel Kahneman. I realized in hindsight we never actually defined these in the course of the interview, so to help you follow along, here are two quick definitions. The availability heuristic occurs when people judge the frequency of a category by the ease with which instances come to mind. For example, you're likely to overestimate

the frequency of Hollywood divorces because they're more reported on and more salient. The representativeness heuristic is our tendency to judge likelihood by similarity, or in Kahneman and Tversky's words, an attribute is representative of a class if it is very diagnostic. That is, if the relative frequency of this attribute is much higher in that class than in a relevant reference class. Here's an example from economist Andre Schleifer to help you get your head around that idea. Suppose you're asked to predict the most likely hair color of an Irish person. Many people say red. It is true that red hair is more common among the Irish. About 10% of them have red hair as opposed to 1% of the population elsewhere. But because red hair is representative

of the Irish, people tend to believe that the Irish are even more likely to have red hair than they actually do. That's the representativeness heuristic. The availability and representativeness heuristics are fast and frugal rules of thumb that helped our ancestors navigate their messy world without succumbing to analysis paralysis. They still help us today, but occasionally they lead to systematic departures of human judgment from Bayesian inference, the correct way of assessing probabilities. Okay, so without much further ado, please enjoy my conversation with the great Bob Schiller. Bob Schiller, thank you so much for joining me. My pleasure.

We are going to talk about efficient markets, bubbles, housing markets, animal spirits, narrative economics, all of the important contributions you've made to the field of economics. But first, I want to situate you for our listeners. And I thought we should begin at the beginning. Tell me, when did you first become interested in economics? How did you encounter it? My brother, who is four years older than I, went off to college, and he brought back his textbook, Economics, by Paul Samuelson. And here I was, 14 years old. I read it. I loved it.

That's how I got... Later, I had the pleasure. I loved it. That's how I got. Later, I had the pleasure. I had Samuelson as my teacher. Wow. I read in your Nobel Prize bio that you're always deeply fascinated by the physical and biological sciences. Why not go into one of those

rather than the dismal science? I think that's kind of random. You know, I'm interested in everything. And at the moment when I had to make, I also thought I should make a once and for all decision and not change my mind. So at the moment when I made that decision, it was partly under the influence of some people that I met.

Maybe, I can't be precise, I met a physicist who said something really dumb about the economy or something. And it seemed to me that economists were the most worldly, at that moment, you know, I may change my mind from time to time, the most worldly of scientists. In fact, Robert Heilbrunner wrote a book called The Worldly Philosophers. It was a book about economists. And he claimed that philosopher philosophers are just too up in the clouds. They're useless. Economists are like philosophers, except they're down there about where is your next meal coming from? Tell me about the mathematics teacher who inspired you when you were 14. Oh, well, I had a geometry teacher in my classroom, in my high school, and he encouraged special projects.

I wrote for him a treatise on spirals. I figured out, using calculus, how to measure the length of a spiral. And I was proving theorems. I kind of surprised him because he hadn't designed anything like that. But I got into it at that point. So yeah, I can talk about my high school geometry teacher. Had you been taught calculus at that point? Not formally. I was reading all sorts of things. I read Edwin Abbott's book, Flatland.

It was written in the 1880s, but it's about higher dimensions. I recommend it, by the way. And I read The Mathematics and the Imagination. It's a book. A lot of teenagers used to read that about famous mathematicians, and it kind of got me a bug for mathematics. Fast forwarding, I read that as you approached the end of your undergraduate career, you were diagnosed with a stress fracture of the metatarsal in your foot, which was typical of soldiers on long forced marches.

What on earth happened to trigger that? Well, as I said, I wanted to make a once and for all lifetime decision. And it seemed like a tragic, it was almost like death, because all the dreams that I had, that I might have had to do something different, would all be crossed off, and I would just go in one direction. I thought it was such an, this is the most important decision in my life. So I went around thinking, walking, at the University of Michigan on the campus. I walked to the medical school and walked all around, just trying to picture myself as a physician. And then I walked to the medical school and walked all around just trying to picture myself as a physician.

And then I walked to different science departments just to get a feel of these. But I did so much walking that, yes, my foot started to hurt. Do you still go for walks when you're trying to think through difficult problems? Oh, yeah. Yeah, I like to walk. I have a treadmill, treadmill though that takes place that's still doing walking but i thought i wanted to focus more on something i'm reading rather than uh being so random and scattered yeah so i i read there's about 130 million books in the world but at an average of a book a day for 73 years, the ordinary human

could read about 26,645 books. Do you view it as a tragedy that you'll never be able to know as much about the world as you would like? It is a tragedy. I tend also to speed read or to jump around in them. I'll start at the end and move to the beginning. I don't have time. Yeah, I'd like to read other books too. I don't have time to just go page by page. I read in your, on that point, I read in your bio that your wife

thinks you might have ADHD. Is that true? That's right. This is a, well, I have to admit, I don't know if I would be the classic ADHD. Yeah. But I do have a problem of my mind jumps. Yeah. And the worst thing for me is a mathematical seminar, actually, where the professor first puts lambda is this and beta is this and lists a whole bunch of symbols and i'm tuning out i can't pay attention to that yeah and then i'm lost for the rest because i don't know what all the symbols mean yeah so it takes a certain talent to be good at seminars and i'm not there yeah see i i've often wondered whether i might have it as well. You know, the symptoms aren't extreme or anything.

But when I was four, my parents put me on medication for ADD or ADHD. And I was on it for a few weeks. Apparently, I went crazy. And my dad, who was a doctor, said, you know, no son of mine is going to be on drugs and took me off them. And I was fine. But I've found it's a strength in the sense that you're interested in so many things. And it's good to be interdisciplinary. Right.

I actually am getting more interdisciplinary as I age. Yeah. So I called my new book Narrative Economics and Adventure in Consilience. Do you know this word, consilience? I do, E.O. Wilson. But tell us what it means to you and why it matters. It goes back, it was coined by William Hewell, who was a 19th century philosopher. Okay, further than us. And E.O. Wilson wrote a nice book, I recommend it, about consilience.

But it's something about how our judgments are enhanced by interdisciplinary approaches. You have to listen to people who have a different toolkit that might seem irrelevant. We tend to become part of a profession, and we think we have all the answers. But you can really build a better case for important ideas if you are interdisciplinary and focused and you listen to people from other disciplines. It makes fundamental sense because there's no reason the universe would follow or obey the demarcations of university departments that humans impose on themselves.

I think this division of the university into departments is kind of unfortunate. That seemed to be a trend starting in the late 19th century. And my department, Department of Economics, was originally called, in the 1920s, the Department of Economics was originally called, in the 1920s, the Department of Economics and Sociology. And then sometime in the 30s or thereabout, they split it into two departments. And now we don't even talk to each other anymore, generally. So I think that they've gotten too extreme one or the other.

Bob, you just did something I noticed when we were talking about consilience, something I noticed you do a lot, which is you always know the history and the etymology of words. You seem to be fascinated by the history of ideas and you always know when the word was first used. Oh, yeah. Do you think that's useful for proving anything other than the history of words or is it just interesting? Well, to some extent, it's a memory trick for me. I learn that I will remember things better. Also, it helps me understand the meaning of words,

and if I know where they came from and what context they developed. Words are very complicated. The definition in the dictionary doesn't do them justice. But also, yeah, I like to waste time thinking about history. What tools do you use to discover when a word was first used? Well, I don't have a systematic approach, but I've learned to, as many people have, search on sites that are historic.

I wrote a book with George Akerulov called Animal Spirits. And I wanted to find out who used that first. Some people say it was John Maynard Keynes, the economist. But that's not, that's easy to, it was an older phrase than that. So then I was told it's Galen, the Spiritus Anomalis, that's Latin for animal spirits. So I was telling people that Galen coined the term, but I thought I better check that. And I found that there are

websites now that will allow you to search in Latin, the ancient world. And I tried Greek too. I forget how to say it in Greek, but it was a popular phrase in Greek, too. And I got it back to 200 B.C. Wow. So, yeah, why do I do this? Yeah, I try to keep my Latin alive, too, a little bit. I studied that in high school. Kept fighting the good fight. Why do I do that?

It's a little bit like traveling to another planet going back in history and reading their in their own words but it would be considered a waste of time by most people well i think it's very interesting and and i agree it does help you remember the words i want to fast forward to mit you went there for graduate school. And after that, you went straight into the PhD program. But you first arrived there in 1967. Do you remember what the prevailing atmosphere was like? And also, what were some of the big debates or the emerging ideas in economics at MIT back then? That's a difficult question. What were people doing in their research at that time? For me, I think it was rational expectations. In fact, the title of my dissertation was Rational Expectations and the Term Structure of Interest Rates. I was thinking about the inverted yield curve, things like that. But from a standpoint of everyone being completely rational,

that was cathartic to me because I got worked out of my system completely, the idea of researching the world as if everybody were completely rational. But that was an emerging theme at that time you had early uh robert lucas of thomas sergeant uh and uh i uh i was hired by university of minnesota with with where thomas sergeant and christopher sims were so i was in into this rational expectations thing. It had the advantage of newness, and it was fun. But I later the audience will be necessarily up on the terminology, occasionally I'm going to ask you to define some terms that will be pretty basic to you. I'm sorry, I won't do it too much. Give us an overview or a brief outline of the efficient markets hypothesis. Well, the term efficient markets was coined by Eugene Fama at the University of Chicago in a 1969 article.

It caught on. It went viral, as I would say, the idea of efficient markets. And so what it means to Fama is that market prices efficiently incorporate all public information. Or it could be stronger. It could even be non-public information, depending on which version of the hypothesis you want to take. But the idea has some attractiveness to it. And the attractiveness is this. When you trade in financial markets,

you are trying to beat the market, let's say, but you're playing a game against everybody else who's trying to do the same thing. In fact, there are some really smart people who are trying to do the same thing, and they tend to get wealthy at first, but the fact that they're now a big player in the market eliminates the profit opportunities that you might have otherwise had. So then markets are so smart, they're smarter than any one person. Even the smart money, so-called, only know about certain corners and nooks in the market. But the group of them as a whole, who don't talk to each other very much set prices and they set them at their optimal level better than anyone could get so if you if you want to forecast this brings

us to the random walk hypothesis yeah explain that too if you want to uh the the market is a market price looks random from day to day uh like a drunk who's staggering so randomly that every step is in a random direction. But it's actually very smart. The reason the market seems so random in its changes from day to day is because it reacts only to genuine news. And genuine news, by definition, has to have been unpredictable or it wouldn't be news. So what appears to be craziness in the market is really extreme intelligence in the market. It's the combined intelligence of all the smart money. That's the story.

And I have to say, I actually give it in my lectures. I have an online course, by the way, Financial Markets, which you can take on Coursera for free. I lecture about this, but I call it a half-truth. It's an insight that everyone should have at some point. And not expect to be able to make money trading on information that's two weeks old. I was going to say the idea goes back to the 19th century or earlier without the name efficient markets. I'm sure I'm doing what you said again.

Yeah, you can't help it. Talking about origins of ideas. Why should we care whether markets are efficient or not? Why does it matter that assets can be overpriced or underpriced? Because investing, successful investing, would benefit enormously from being able to detect when an asset is overpriced or underpriced. And the claim from efficient markets theory is that you're wasting your time. You can fritter away your youth playing the markets, and the outcome is just random. And that's a scary thought.

Don't waste your time. I would say, though, that the answer should be don't waste your time unless you're putting in enough effort to make it really work, and that you have real reason to think that you are above average in this skill and i suppose it also matters for society more broadly because even assets underpriced incentives are created to neglect or abuse it or when it's overpriced incentives

are created to invest too much resources in it uh australia is learning this at the moment with a huge glut of uh compromised apartments being thrown up around sydney and melbourne a compromised apartment apartment buildings like condos a lot of them have um structural damage or building problems yeah uh so bob you mentioned your phd dissertation which was about the efficiency of the long-term bond market. Between that dissertation in 1972 and 1989 when you published your book Market Volatility, which was a collection of the last 12 years of your work and advanced the view that changes in speculative asset prices might be explained by psychology and investor irrationality. In that period, what were the major turning points for you? When did you start turning away from the efficient markets hypothesis?

Did you have a sort of a road to Damascus moment? Maybe it was turning in my dissertation. Right. I was done. You know, one problem that you have as a graduate student is you have a timetable. You have to get out and get a job, right? And you found something fun, but as time goes on,

maybe you're less convinced that it's an important idea, but you've got to finish anyway. Yeah. Another moment came when I accepted a one-day-a-week appointment at the Federal Reserve Bank of Philadelphia as a visiting scholar. And I was there in the real world again where monetary policy was being made. And that left me, oh, they were asking for thoughts about volatility. How can we predict it or what does it mean? So that led to an article I wrote in 1979 about the volatility of interest rates. And then 1981 about the volatility of interest rates. Yeah.

And then 1981 about the volatility of the stock market. And I thought, you know, this whole story about efficient markets that attributes all of the movements in the stock market to new information, it just isn't right. It's not new information. It's something, well, maybe it's new information about the folly of some investors, but it's not new information of the kind envisioned by efficient markets theorists. How would you describe Eugene Farmer in relation to your work? Like an arch nemesis or better noir? As I was saying that, somehow Eugene Farmer's face appeared before me. I was leaning to that, I guess.

Well, he and I won the Nobel Prize together with Lars Hansen as well. But we were the two extremists. Lars Hansen was embarrassingly in the middle and didn't have anything dramatic to say about these points. So, yeah, Eugene Fama says that he's opposed to the behavioral finance, and he is opposed to the whole concept of a speculative bubble. Yeah, the nasty B word. The B word. Yeah, that's right. But the funny thing is I spent a whole week with him, Nobel week, and I heard the answers he gives to questions. And you know we're not that different. It's almost like we have different ways of describing the same thing.

So when I say irrationality, maybe he would say tastes are changing. I don't know. He doesn't want to assume anything is irrational. Maybe he's just being polite maybe i'm insulting some people by talking about behavioral finance he also will tell you that it's not easy to invest and make money beating the market we're agreed on that and he and he also doesn't think it's impossible in some sense to beat the market because he has a company called Dimensional Fund Advisors, which invests hundreds of billions of dollars for other investors. So they must believe in him that he's doing something useful. But he won't tell you that he's beating the market. He's advising you on how to make,

for your risk preferences and your special needs, how to form a portfolio, a well-designed portfolio. But it's a little bit like politics. I never wanted to go into politics because I couldn't keep up with a straight face, the party line, whatever that is. But it does invade thinking and economics within the university politics. Well, on that point, I wonder whether to borrow a line from a paper by the moral psychologist Jonathan Haidt.

Farmer is letting his emotional dog wag his rational tail. And I don't mean to suggest he's dishonest, you know, he's an honorable man, incredibly smart, but everyone's biased to an extent. And I remember reading a couple of interviews he'd given where I thought, I wonder whether he just doesn't want to accept the existence of bubbles because they would threaten his worldview or political ideology. Right. And I had a couple here, a couple of quotes I thought I might read out. One was from a 2015 interview on EconTalk with Russ Roberts, where Farmer was referring to the nasty B word. And Russ asked him, how does he explain awkward facts like the US housing collapse?

And Farmer said, well, we had a big recession. If we say there was a bubble in the housing market, we also have to say there were bubbles in the commodities, bonds and stock markets. Do economists really want to live in a world where that's possible? Yeah. And another quote. Well, actually, this one's from. Is that a direct quote? That's a direct quote, yeah.

Want to live, economists want to live in a rational world. Exactly. So they'll make the world rational for themselves. This is a quote from Scott Sumner, who's an acolyte of Milton Friedman, another son of the Chicago school. But Scott Sumner said, I don't believe in bubbles. In addition, I'm a libertarian. I see those two facts as being related. Thought he was being incredibly self-aware there. But it's also interesting to me that Farmer describes himself as an extreme libertarian.

Yeah, so libertarian is a movement, a 20th century movement. It extends back to earlier movements. I think of the anarchism movement of the 19th century and extending into the 20th. And it has ramifications today in Bitcoin, for example, which is kind of made interesting to some people because of the sense that the government can't get to this. We're not asking anyone's permission. The government can't take it because it's their cryptocurrencies. So there's always been an attraction to some element of the population, to anarchy or free markets, libertarianism, and now Bitcoin. So there are certain patterns of thinking that are not shared by everyone,

but shared by a lot of people. It's a sort of sense of animosity toward someone who would proclaim to set regulations on you. Yeah, exactly. And I guess what I'm getting at is that it seems for Farmer, if he acknowledges the existence of bubbles, then in the same breath he acknowledges the necessity of regulation. That sounds right, yeah. Do you think that's the core of the issue? Well,

it's a little bit hard. You need a psychiatrist to get people's undercurrents. I know that I can detect it. There's an edge. There's an edge. There's an edge that when you transgress it, you can see sparks flying in people's eyes. Although they do have a point that markets, as Adam Smith described it, markets allocate resources and production. So if there's a cold winter,

then you don't have to have a government official telling the coal mines to mine more coal. They see the price of coal going up, so they put their workers on overtime, and they get it out faster. That's an old example. It makes sense. The governments don't have to allocate or tell the coal mines how much to mine. Now they do though because of externalities, global warming. And so there's another thing that libertarians will probably concede, but they don't like the sound of it.

In Farmer's Nobel lecture, he defined the word bubble as being a strong run-up in prices followed by a predictable strong decline. How do you define the word bubble? Okay, I'm using a word that originated, here I go again, sorry, in 1720, boule in French. There was a stock market crash in Europe. This is before there even was a stock market in the US. And they refer to it as a bubble. This was the South Sea bubble. Yes, right. Yeah.

And so I think they were bringing in a metaphor that's a little bit unfortunate. It sounds like when you're blowing up a bubble, a soap bubble, you can picture that. You're trying to get it as big as you can. Yeah. But it has a limit. It can only get so big. And then, pop, it's gone. And it's final and forever. That bubble will never be seen again. But I think that's unfortunate because bubbles aren't,

that's not a characterization of something that happens so definitively and so suddenly. It reflects, that definition, which is a popular definition of bubble, reflects habits of the news media. They like to talk about one-day events, especially if they're a daily publication. They like those one-day events. But bubbles don't burst suddenly like that. So I have a different, if I can go on, a different definition of bubble. A bubble, I'm trying to quote myself here. I can't do it as well as I do it in my book, but it's a period of rising speculative prices that attracts attention

and reinforces itself by new investors who might not otherwise be interested in this particular asset to start investing in it and thereby pushing prices up further. So it's a feedback loop and it's accommodated by changing narratives or stories that surround the commodity impression or whatever the investment is in question. Particularly new era stories that are fanciful creations of somebody or other that might logically, rationally explain the price increase. So stories like the Celtic Tiger. Yes, right. So the Celtic Tiger was referring to the Irish real estate boom around the same time, in the late 1990s. And it was a time when the Irish economy was developing and lots of people were getting solid educations.

They were bright young people and more headquarters were being moved into Ireland. So it sounded like something that would go on forever. And I don't know if there was another earlier bubble in Ireland. So they didn't have anything to compare with. Maybe there was. There probably was. I just don't know about it. so they didn't have anything to compare with. Maybe there was. There probably was. I just don't know about it. Maybe they didn't know about it because they weren't talking about it. And so they were pushing prices up to the point that only people who

expected to make a lot of money by further price increases would want to buy it. So when the price increases stop, these people think, why am I holding on to this asset? I didn't even want this bigger house. I'll sell it, and then I can live off the proceed. That's how it starts coming down. So for you, a bubble is, or at least the emphasis of your definition is more on this broad psychosocial phenomena of excitement around price rises that's right it's a it's a there are other in my newest book narrative economics i'm going broader than uh than uh just speculative markets. A narrative develops, and it's spread by word of mouth. It goes viral, although that's a new term,

relatively new term to say something went viral. You're thinking about the Internet or the social media. But things went viral in the ancient world, too. It's not new. But, yeah, that's the model that I'm... So it's not just stock prices, it's not just housing prices. It's general attitudes that bring on booms and recessions as well. Bob, people generally take the Dutch tulip mania, which crashed in February 1637 as the world's first bubble. Have you found any examples that are older than that? Yes, there was.

Well, not by the way, the best answer to that question is not much. Right. And I think that the curious fact about the tulip mania, and you said 1637, was that the Netherlands was the first country to allow a free press. Every other country in the world at that time censored, they didn't trust the news media. But Netherlands had some enlightenment at that time and allowed newspapers to freely discuss things. Now, I once asked someone who spoke Dutch to try to research and find some discussion in the newspapers of that day. He wasn't successful, but I don't think of that day of bubble.

He wasn't successful, but I don't think they have all of them. They're not all kept. There were pamphlets, I know, describing the bubble. So I think that the contagion was facilitated with the advent of newspapers in the early 1600s and printed newspapers. But there were examples of bubbles that I think it was in Livy, History of Ancient Rome, talks about, he doesn't use the word bubble, of course,

but he said home prices in the capital, Rome, were increasing. I'm quoting very loosely here from memory. That's okay. And people are talking about it. Why is this happening? And he had an explanation. And it was something about the Roman Senate

had passed a decree that senators had to own property in the city. Something like, I'm sorry, I'm not saying that's exactly right. But here it documents that prices were going up, to own property in the city. Something like, I'm sorry, I'm not saying that's exactly right. But here it documents that prices were going up, people were talking about it, and they were advancing theories why it was happening. This happens to be an efficient markets theory, I guess. You're blaming

it on the government. Wow. So media is necessary for bubbles. And I guess that kind of makes sense because you need the media to spread the stories to ensure that the contagion rate is sufficiently high. it happened i should have looked this up but there was a newspaper in ancient rome called the acta diurni and it wasn't something that uh you could get a subscription to it would be posted in uh maybe you could but it would be posted in public squares and a crowd would form around it reading the newspaper but none of it survives there's some quotes from it that survive. They know that the newspaper reported a comet that appeared in the sky. So it was sort of a general interest newspaper if they

would report something like that. But we don't know what they might have said about ancient Roman bubbles. Not much of it survives. When people ask me for book recommendations on bubbles, I generally begin with two tomes. One is your book, Irrational Exuberance, and the other is Charles Kindleberger's Mania's Panics and Crashes. Do you remember when you first met Kindleberger? I took his course in international economics as a graduate student at mit so i was at mit yeah and that i'm sure influenced influenced me a lot i think i later wrote to him when he was very uh late in his life and thanked him for his inspiration in the uh appendix of his book famous first bubbles peter garber calls charles kindleberger's uh manias panics and crashes a quote-unquote cubist study of manias uh cubist cubist yeah

like like cubism the art the art form that emerged in spain do you think that's a fair criticism i i don't quite understand what is a cubist analysis i think he kind of meant that it was like a narrative-based approach to bubbles it was it was like it was almost anthropological uh yeah uh economists uh like format formal analysis And I think that when they evaluated Kindleberger, they may not have thought that book was serious. He did other things that were more formal and logical. So I met Ken Rogoff, who wrote a nice book about financial markets called This Time is Different. Yeah, with Common Run. That's right, yeah.

So I was talking to him, and I don't know if he meant this for a quotation, but he said one of the Harvard graduate students came up to him and said, I loved your book, but I have another question. When are you going to get back to research? And Herkhoff thought that was funny, that this book isn't research. It's a wonderful book, but it's about every financial crisis back 800 years. And it's narratives, and it's data when they could get it. But to me, that's a very important way of getting an understanding, reading about all of them and trying to make generalities about how they started or what happened. I read a really charming newspaper article.

I think it was the Wall Street Journal. I've just stumbled upon it recently, but it was an interview with Kindleberger when he was 91 or 92, about 2002. And they were speaking with him about his life's work. And at the time of the interview, he was busily cutting out newspaper clippings of stories about the housing market. Okay. And I asked him what his big concern was at the moment. And he said, it's the housing market.

I just found that kind of charming. So, what year was that? 2002. It was the year before he died. Yeah. But I just thought that was kind of a cute image of this old man hunched over the table, cutting out newspaper clippings. Yeah, we don't have to clip them anymore. That's right, yeah.

Or use the snipping tool. The snipping tool, yeah. You know what I mean. Coming back to something you mentioned earlier, Bob, just to sort of wrap up this discussion of bubbles, you mentioned the efficient markets hypothesis is a half-truth. And I once heard you use a metaphor to describe this. You mentioned the drunk, but I once heard you say something additional to that. And the reality of markets is they're like a, or of price movements, is they're like a drunk who starts at a lamppost and starts wandering home.

That's the random walk. But he has a big elastic band attaching him from the ankle back to the lamppost. So ultimately he's sort of drawn back. What did you mean by that metaphor? Well, yeah, imagine that it was a long elastic band and it didn't put any pressure on him when he was close to the lamppost. You couldn't really distinguish, you couldn't tell that from watching him for a brief time that he was ever going to get back. It looks random. I show my students a plot of a random walk and another process, which is almost a random walk, but with a slight bias back to something.

And they can't tell them apart. You have to look for a long time. And so markets that are getting pricier and pricier, like Australian real estate market, for example, in recent years, it goes on for so long that you think there's no elastic band here. It should have pulled them back by now, but that's not necessarily. It depends on how elastic the band is. There's certainly still going to be a limit limit and it's going to come back. That metaphor, that image suggests that you and Farmer are both correct. Well, that it's, yeah, we're both correct

in the sense that it's difficult to make money beating the market. But it's not impossible. In fact, there are studies I really like the... There was a recent study that looked at... They wanted to get IQs of investors, but they couldn't get that and compare that with their performance. But what they did do is they got data. This is Judy Chevalier and Glenn Ellison who did this study. They got data on the average aptitude test scores for students in the college they went to. So they could find out for each professional investor which college, that's on their curriculum VDI, and that's a very, very rough estimate of their intelligence because colleges accept,

some of them have higher scores on average than others. And they looked to see how their performance correlated with their aptitude score. And they found a substantial correlation. And I tell my students, Yale University, where I'm teaching, our students perform something like 1% or 2% a year better than students at a very weak university. That's not a whole lot, you know, 1%. So what's the big deal? Well, it's a big deal. It adds up, accumulates over a lifetime of investing. But it's not such a big deal that

you necessarily want to become a finance expert. Maybe you don't need that extra money, and so forget about it. Just invest in a broad, diversified portfolio, and that's a fine decision too. So that's where efficient markets and behavioral finance can sometimes agree. Eugene Fama is a brilliant man, and I fully believe that in the long run, investing in his recommended investments probably will outperform, if he's still paying attention. I don't know that for sure. Doesn't get too carried away on the golf course. So, Bob, let's move briefly to the question of animal spirits, because if we can't explain market movements by completely rational actors, maybe animal spirits affords a better explanation or a more complete view of markets. And the point I want to wrestle over with you is how we quantify animal spirits. And I want to read a critique of a paper you published in 1984. So in 1984, you published a Brookings paper titled Stock Prices and Social Dynamics.

And one of the critiques of the paper was by Stanley Fisher. And he wrote that, quote, nonetheless, he praised your paper, and then he wrote that, quote, nonetheless, the paper does not bring much direct evidence to bear on the issue and leaves the links between social fads and excess volatility vague, end quote. Almost 35 years later, it feels like you're still struggling with this problem. Well, it is difficult to quantify fads. They seem palpably obvious. You talk to someone, and he says something wild. You think, how can he believe that? And you feel like you know. But how do you write down a mathematical analysis, statistical analysis that would show correlation? Well, this is something that's improving though. And as I argue in Narrative Economics, my newest book, I think that a revolution is coming in coming decades decades in economics because now we have digitized text. We have ability to observe

not only newspapers, books, and magazines, but also church sermons and personal diaries and other things that are digitized. And with natural language processing, I think we're going to develop new measures of the very animal spirits that's fluctuating. It won't be such a mystery anymore. And I think that revolutions in science often or they generally occur after some new data source is developed. So, you know, Newton's Principia Mathematica came after Kepler gave accurate measurements of the movements of the planets. That sort of thing happens all the time in science, and I think it's happening now.

I think this is a good time, if you're willing to be a little bit edgy, to go into economic research. Graduate students are, I think, generally a little bit too conformist to what seems like the current received wisdom. And I keep telling them, you have to do something different.

And so something to do with analysis of digitized text, I think will be one major area for further research. Daniel Kahneman advanced a metaphor, a way of understanding our cognition in his book, Thinking Fast and Slow. He talks about system one and system two. They're sort of the two characters or protagonists of the book. And system one is our fast intuitive thinking, and that's the world of cognitive biases. System two is the slower, more effortful thinking. I often think that animal spirits include system one,

which is all of Kahneman and Tversky's biases, you know, the availability heuristic, the representativeness heuristic, anchoring, and that's sort of, I guess, perceptual cognition. But it might also be worth hijacking the metaphor and talking about system three, which is the realm of social cognition, mimetic desire, conformity, contagion. And of course, this isn't very accurate at the level

of the brain, but I'm just kind of hijacking the metaphor for the convenience of the conversation. But do you think animal spirits, is it fair to say they include both the system one, you know, the individual biases, and also system three, the social contagions and that kind of world as well? Yeah, it does. And I'm wondering why Kahneman didn't do that. He shares a psych department with social psychologists. That's one realm of that department. But it's not something that he was... See, everyone has a certain interest in their research

that kind of drives their passion. So my interest in research came from observations I just made observing people. I remember as a student at the University of Michigan, which had a big football team. It was big among the students to watch football. I went to a football game only once when I was a student there, and I thought, look at these people.

They're so excited by this game. Why do they care? I don't care whether we win or not. It still sticks in my mind that there's some mysterious social element to all our thinking. We tend to fall in step. And that was animal spirits. So somehow being there in the stadium and having a rival university challenging you, wow.

I remember watching a video on christmas day 2018 it was on bondi beach in sydney and it was a spontaneous rave someone started playing some music and a huge group of tourists started gathering but then locals as well and so there was this huge crowd on the beach kind of forming like a mosh pit everyone wearing you know santa hats and hundreds of people and someone had taken drone footage panning over the the crowd but i remember watching it and almost getting chills just thinking there's something intensely groupish about our species and you'd never see that kind of behavior in another primate it looked it looked like bees or insects kind of swarming together oh yeah you can see it in

in bees yeah you can certainly see it in bees yeah um yeah so system one and system three, we've spoken about that. Now, so I think one of the best System 3 accounts of bubbles and markets is your book, Irrational Exuberance. I think one of the best System 1 accounts, this book was like an epiphany for me, was a recent book. It came out at the end of last year. And I know you've read it because you gave an endorsement to it. It was Andre Schleifer and Nicolai Genioli's book, A Crisis of Beliefs. And they use Kahneman and Tversky's representativeness heuristic as a model for the psychology of speculation and extrapolation.

I thought that was just brilliant. Yeah, Andre Schleifer, well, the one I know quite well, has been a leader in helping understand market inefficiencies. So he also wrote with Rob Vishney. And modeling of, I'm thinking of, the idea that I mentioned earlier, that smart money takes over the market

and eventually commands it, is of limited correctness. People who are their sharpest when they're, say, in their 20s have no reputation to attract investors who would have them manage their money for them. And so they might have had risk-taking talents, but they're worried about making a mistake and seeing their reputation go down.

So they don't fully take account of their risky profit opportunities when they're young. And then they get old, it's too late so the idea that somehow the market is able to reward the smartest people uh is uh is not quite right it's only a half truth yeah uh and uh yeah jenny ole and schleifer had a number of interesting points and mathematical models in that book about dynamics of speculative markets. That's right. And something they do is use or analyze survey data of investor expectations. And you've been a huge advocate. Some of mine was in there.

I was hoping you could tell us the story. So there was a big stock market drop on the September 11th and 12th of 1986. And you immediately... I'm sorry. Oh, 86. You're talking about the precursor to the big one. That's right. Yeah, that's right. Tell the story of how you sprung into action and what you did. All right. So in 1986, there were some big stock market drops, but not history-making. But it got me thinking. I listened to the news accounts of those 1986 drops, and I thought, they don't know what they're talking about.

People decided to sell, but nobody's asking them why. Newspaper reporters, their procedure will be on a day of a big drop in the market, is to call up some famous man or woman and ask them what happened today, and the person will tell what the story is. But it didn't seem to me that that's the same thing as asking actual people who actually sold. So then on October 19, 1987, this is months later, well, almost a year later, over a year later, I had been primed to think that why doesn't anyone ask? Then we saw an over 22% drop in the Dow in one day.

It had beat the previous record by a factor of two for a one day drop in the market. And I thought, wait, this is, this is the time when I bet no, I was wondering, will nobody do a questionnaire survey and find out what people were doing on that day? And I thought, I'm going to gamble on there not being anyone else doing it. So I was the only person in the world who sent out questionnaires to America. I didn't do it

internationally. I sent out hundreds of questionnaires. I think I had like 600 responses from individual investors and similarly from institutional investors. And I asked them, what were you thinking on that day? What news story prompted you to sell, if any? And I asked them to tell me what they thought in their own words. So I have actual words from investors. Now, most of them who filled out my, I got names of institutional investors and individual investors. Most of the individual investors didn't buy or sell on that day.

It was actually something like 10% did. I don't remember exactly. But they were very involved in thinking about it. One of my questions was, did you experience anxiety with symptoms like rapid heartbeat, sweaty palms, or the like? I don't have the exact number, but a significant fraction of them had that experience. And they didn't buy or sell. And they had problems getting through and finding out what's happening. They thought it was 1929 again, maybe. So what was the big news story that I got from them? What was the story that got you awake and made you sell?

It was the market itself. They were primed by drops in the preceding week. And they stood about it over the weekend. And then there were even bigger drops the following Monday, and they just didn't know what they couldn't reach their broker. They couldn't get advice. They just dumped their shares. That's what they told me.

So it came out as a psychological reaction to each other, just like in the sports stadium. As far as uncovering investors' system one biases, there seem to be a couple of problems with using survey evidence. One problem is that because biases are intuitive or fast system responses, by definition, people aren't conscious of them. But the second problem is, if we draw out the fallacy clearly enough to reveal the investor's belief in it, then respondents could be educated out of the fallacy by the very questioning intended to uncover it. So how do you think about using survey evidence in light of some of these issues?

Well, survey evidence is imperfect. Yeah. But it is true that we can teach people out of some of their inherent biases. And it helps for them. You might just tell them that there is an inherent bias. But that doesn't mean that there isn't still some tendency for this bias. I could teach someone to hop on one foot instead of walking, all right? And you could do that if you thought that was needed for some reason.

But, you know, you're going to get back to walking. It turns out that we evolved to walk, not to hop on one foot. So, yeah, Gerard Giekerenser had particularly prominent in criticizing Kahneman and Tversky for describing errors that people don't make after they're trained. I'm not sure they don't make, they still, some of them are hard to avoid. For example, the affect heuristic. That's Paul Slovic, psychologist's term. The affect heuristic is a tendency to

change your behavior in response to an emotion that is unrelated to the object of your current behavior. So you're driving to work and you see a horrible traffic accident and you're all upset. You arrive at work and then you make very cautious decisions on that day in your, say, investing or whatever it is you do because you can't escape the emotional feeling from what you just saw. So that's system one. But they're all there.

The system one, two, and three are all there. And so we can't over-rely on just one of them. Yeah. I say that you're using my metaphor. I like it. Yeah, I caught it caught it next time i will say it and i won't even quote you i won't even credit you sorry about that let's make it go viral um bob i've had ed lemur on this podcast i had him on during my housing bubble week the

seven part series i did back in may and i've stayed in touch with Ed. He regards himself as an admirer of your work and before this conversation, I asked Ed if he had any questions that I should ask you or that he would ask and he said, so these were some of Ed's questions. So, Ed to Bob, can you explain what psychology can add to traditional economic theory, which already allows for differences in preferences and differences in knowledge to affect rational decisions? How can you diagnose an irrational decision? What decisions cannot be explained either by preferences or knowledge? That's a big and very broad question. I taught a course in behavioral economics,

and I spent a whole semester trying to answer that question. I think that one thing, to give you an example, is that we have a new young generation of researchers who are doing empirical research on human behavior in economic sphere. Someone who is solely into the rational model would say that government regulators just have to announce their information and people will be taking advantage of that. Or tax authorities, they just decide on the tax rates and don't have to consider whether people even understand what they're doing. The young generation today in economics, many of them are doing experiments to see what really works. So for example, they'll go to a less developed country that has a lot of poverty. And try experiments with people there to see what will happen. So, for example, they look at farmers in a poor country who are not using fertilizer.

And so they ask the farmer, why aren't you using fertilizer? And the farmer, he said, what do you think is the answer? He will say, I ran out of money. I can't buy it. So they get the farmer to sign a contract right after the harvest when they're rich. And to buy fertilizer, to have it delivered to them at the right time. These don't sound impressive to an economist, but they work, these kinds of things. Helping people overcome the mistakes that this farmer was illustrating myopic behavior.

Not when he ran out of money. He shouldn't have run out of money. So their self-control is an issue. So a lot of things are... So things that we have have value because of behavioral reasons. So, for example, we tend to buy houses with mortgages, but we have amortizing mortgages that pay down your loan through time

instead of a balloon mortgage where you pay it all back at some future date. Advertising mortgages work better because it enforces saving. People, because they have a regular monthly payment, they just do it and they end up owning the house. These things are empirically very important and they can guide policy to make it work better.

We're learning that all the time. And now in London, there's a behavioral insights team that was set up by the government. Now there's many of these teams all over the world inspired by behavioral economics. Bob, here's a final question from Ed Lima. What about macroeconomics bob has done a lot of work on housing does he think the housing cycle is some kind of mad crowd disease that could be treated with wisely timed depressants and antidepressants you don't you don't have to answer that because we're going to move on to housing markets now um so yeah this is okay i've enjoyed all of our discussion but this is the part that i'm looking forward to perhaps the most because of what's happening in Australia at the moment. But I want to begin discussing housing markets and housing bubbles more broadly with you.

And I wanted to ask, do you remember when you first became interested in real estate markets? Yeah, I think that was in the 1980s. Maybe it was sometime in that. In the Northeast United States, there was a boom in home prices. Now, remember, I did a study of the 1987 stock market crash. So I was thinking about the stock market. But I thought, well, the real estate market is doing the same thing. So I found a co-author, Carl Case at Wellesley College,

who is a real estate expert. And I said, let's just ask people what accounts for their willingness to accept higher prices. And we did that. It's just that it seemed like the housing market is such egregious inefficiency. They just keep going up for 10 years. And then they'll go down for five years.

So what we did is we found that there was very limited study of the efficiency of the housing market at that time. And part of the problem was there were no good home price indices. So we developed what's now called the Case-Shiller Home Price Indices that are now published by CoreLogic and Standard & Poor's. But these were good indexes and you know what? They were very smooth through time. They didn't look, when you plot the prices, they didn't look jagged and choppy like stock prices. They confirmed our impression that they just

keep going up for years and years. And then when they finally turn, it's not turn on a dime like it is with 1929 crash. They start slowing down and then they start... I know Australian prices are doing the same thing. Yeah, we'll talk about that. Australia is an interesting example because they're so volatile. But it's still basically the same thing. My favorite paper of yours is the paper you did with with with chip case called the efficiency of the market for single-family homes um right and you've spoken about how the housing market is woefully inefficient

um what what did you what did you discover in that paper specifically in terms of prices? Well, there is momentum in the home prices. Momentum, right. And we were publishing forecasts after that for years in the Wall Street Journal. And we could forecast out one year with about a 50% success. By that I mean we could explain about half of the variance in variability of home prices. The simplest model was just based on extrapolation. It would go the same way next year as it did last year. And if it's speeding up,

it might speed up some more. If it's slowing down, it's a good chance it will keep slowing down. So that's, to me, a description of a market that's narrative-driven It's a market difficult for professional investors to trade in. Otherwise they would do more trading in it and they would make it more difficult to make money, to see a trend. Because it's difficult for them to trade and they costly and they can't know what the local neighborhood effects are on the prices. So they might make big mistakes. So that means that we showed plots of home prices that were not jagged.

The only source of information on home prices at that time were median prices. But median home prices were very jagged and choppy because different kinds of houses sell at different times. So we came up with, that was really the launch of the Case-Shiller indices. And it was the beginning of interest all over the world in actual accurate home price indices. So when you created your repeat sales index, it would have been like looking through a microscope for the first time. You had sort of a clearer view of reality. Do you remember the feeling of when you first looked through that microscope and you realized how inefficient?

You can find on the web, maybe Project Gutenberg or something like that, a book by Thomas Hooke called Micrographia. And he has engravings showing what he saw through the microphone in the year 1650-something. Oh, wow. Amazing book. You can try to read it. And the famous thing he discovered there is the cell. He discovered the cell in that book. Yeah, so what we did is drew an accurate graphical depiction of the market.

And I think that it influenced people to wonder about this bubble in the housing market. It's interesting how people kind of automatically extrapolate from stock market efficiency to housing market efficiency. Sorry to keep coming back to Eugene Farmer. This will probably be the last time. But I read an interview with him in 2007 where an interviewer was asking him, are housing markets efficient? And his answer was, I'm quoting directly here, I don't know. Housing markets are less liquid, but people are very careful when they buy houses. It's typically the biggest investment they're going to make. So, they look around very carefully and they compare prices. The bidding process is very detailed.

The bottom line is that real estate is a huge component of wealth and we have no data on it. So the answer to your question is who knows. So he was kind of leaning towards saying that they probably are efficient for these reasons. But I mean, you've already mentioned some of them. There are plenty of reasons to believe a priori that real estate markets would be woefully inefficient. You mentioned that because of the high transaction costs, it's very difficult for the smart money to trade. That's another reason itself. There's no smart money.

There's a lot of amateurs. I guess also you can't short sell houses because they're heterogeneous. All those things would lead us to expect a very inefficient market. Well, I'm glad that Eugene at least recognized the possibility that they're inefficient. That was a good moment for him. If you want to think about market efficiency, how about lottery tickets that are issued by governments? Now, you and I probably think that they're basically a losing proposition, right? They're designed to be random, and they take a take every time.

So they don't come across as anything to invest in, unless you can resell it to a greater fool. I don't think that works. So it's very plain that people aren't automatically good at it. Now, Gene is right that people do care about housing when they make an important purchase. And they may agonize over it, but they don't show much interest in the history. When Chip and I published, I think, our home price index,

there was no good index at all. If you go back to the 1940s, let's go back a little further, what could you find out about home prices? Well, the National Association of Realtors in the U.S. wasn't publishing anything like that. They only had a survey in which real estate brokers were asked to describe whether the market is hot or cold. That's all. There was nothing. And so when I wrote the second edition to my book, Irrational Exuberance, I computed a home price index for the United States back to 1890. So I had over 100 years of home prices. And you know what? Nobody had ever seen that before.

So how do you expect people to form rational expectations if they don't have, they A, show no interest in the data, and B, they have never seen the data. So the judgment about whether there might be bubbles in home prices. Oh, the other thing is that one reason why people weren't interested in home prices is that in the period, in the middle third of the 20th century, the market was kind of tame. There were big bubbles in the 1920s and in the 1880s, but that was history. It was a long time ago. And the market wasn't so volatile then. And people were less speculative. So I think that the attitude toward home prices, let's go to the year 1950, okay? What did economists say about home prices?

They typically said, oh, they're guided by construction costs. Best thing to do is wait. Technical progress will bring construction costs down, and you'll be able to get it cheaper later. They thought it was like, I like to compare it to automobiles. Whoever hears of speculating in cars,

did you ever hear of someone buying 20 cars and parking them somewhere and waiting 10 years or trying to flip them at higher price? They just didn't think of it. They believe, most people, that home prices are, except in special areas, they're construction cost driven. So it wasn't a national pastime. But it did become increasingly volatile in the 70s, 80s, 90s, and theories about Asian

buyers started to come in. theories, the story that we're running out of land, that they don't make any more of it, we're increasingly popular. So I've read in several places, Bob, that you think a better way to model housing markets is as informational cascades. And I read this in a newspaper article you wrote around the time of the US housing collapse. I've also read it in papers by other economists, for example, a paper by Morgan Kelly, the Irish economist who was one of the few

who called the Irish housing bubble before it burst. And the idea of an informational cascade is that people are sort of in a queue and they make a decision about whether, for example, to invest in the real estate market. And they can observe the decisions of people acting before them in the queue and they might react to those signals in a way that can kind of generate this snowball or self-reinforcing effect in the queue and they might react to those signals in a way that can kind of generate this snowball or self-reinforcing effect where once you have a few people who've opted in favor of something it has a lot of social proof and it begins to to gain momentum i wanted to put an

idea to you and see what you think because i'm not sure if you if if it's still your view that informational cascades are the best way to model housing markets but uh during my my housing bubble week uh one of the guests i had on was the economist tamor quran uh and he and cas sunstein uh originated this idea of an availability cascade which is an informational cascade combined with a reputational cascade. So in other words, people aren't just acting because they think other people are providing informational cues, but they're also acting to sort of protect their reputations or because of peer pressure. And this hybrid cascade is mediated by the availability heuristic uh and at first it sounds like you're kind of

throwing three concepts into a suitcase together and letting them rattle around but but it is tighter than that it does make sense because the availability of the idea that housing is a great investment or house prices never go down is a function of the cascade because people converse with each other and read media and eventually you get to this point where the cycle has reinforced so much that the collective memory is or the consensus is almost that um that this is the truth it's bricks and mortar is the best investment housing's the best investment for the long term, all the sorts of things that I hear people say in Australia at the moment. And I like thinking about housing bubbles as availability cascades. It's a little more exotic than talking about them as merely informational cascades. But I think it's kind of neat because

it combines system one and three. You have the availability heuristic. That kind of goes to system one. But then the informational and reputational cascades, that's sort of the system three explanation. And I think it's important to include the reputational cascade because there does seem to be this really tense conformity during housing bubbles. If you speak out against the bubble, you're kind of attacking the net worth of homeowners. I know that. Yeah. And a lot of people have experienced this. I mentioned Morgan Kelly. He was almost treated as an outcast in Ireland when he was calling out their housing bubble. But also my friend, Jonathan Tepper, the founder of Variant Perception, he's kind of identified the Australian housingian housing bubble but he identified the spanish

housing bubble uh back in the 2000s he was originally he was born in and grew up in madrid um and he was blacklisted by the government and banned from speaking to media um but so so they don't do that really they did they blacklisted They blacklisted him, yeah. It's an incredible story. That's pretty extreme. I didn't know that. So what do you think about this idea of talking about housing bubbles as availability cascades? It reminds me that I once did a search of the Federal, their working papers, just before 2007 to see if they were warning about the bubble. And I did find at least one paper that mentioned bubbles.

And it said something like, this is like in the year 2005, something like, it might appear that this is a bubble, but we strongly recommend caution in interpreting these results. So they kind of raised the idea and backed off from it. So I asked one Fed researcher about this. Why didn't it even get discussed in all of your... And he gave me... Maybe I shouldn't

quote him. I won't even give you his name. But there's something about the atmosphere that the Fed might be in the business of stabilizing, not disrupting consensus. Yeah. So, yeah, it seems like it's hard to buck the trend.

So in a housing market booming, you feel, I was doing the same thing. You feel kind of at a loss. It doesn't seem to be received well. You get much better response if you tell some story about how much somebody made that we know. That gets a good response. So, yeah, human nature, I think, is something that economists should not forget. Yeah. Bob, you just reminded me of something. In housing bubbles, economists and central banks and people who are invested in the market approach during their housing bubble. There's a few famous ones from the United States Bank of New York's Economic Policy Review. It was titled, Are Home Prices the Next Bubble? And they answered the question in the negative.

And then there was also Margaret Huang Smith and Gary Smith's paper, which I think might have been the last serious paper to argue there was no housing bubble. It was published in March 2006. And it was, I mean, there's lots of examples in Australia too. I guess there are sort of- Gary Smith, by the way, has a new book about errors people make with statistics. Oh, there you go. So now he's an expert on that. It's a good book, by the way. Okay. You recommend it.

But I suppose that, I mean, there were idiosyncratic problems with each of these papers, but more fundamentally, there's an issue with the whole fundamentals approach of trying to explain prices according to, for example, interest rates, income, population growth, supply. Can you speak to that? Well, there's a problem in all of financial research of data mining. Exactly. So there's so many different variables that you might use, especially with home prices, which are very trendy.

If there were a lot of short-run fluctuations, then you might have some hope of explaining those. It turns out the short-run fluctuations are mostly seasonal factors. So, yeah, you can explain it by the calendar, but that's all. So they also take place over such a long interval of time. We don't have data going very far back. These are big lifetime events, these housing bubbles.

Yeah. One way to explain the difficulty with this approach might be to imagine a situation where you run a regression on house prices, on know interest rates income employment and all the other fundamental variables people like to talk about and say your regression residuals are you know suggest that that housing's overvalued by about 10% assume prices actually rose twice as fast um right they'd like they'd probably be 110 overvalued but but the residual would just say that they were 20 overvalued yeah yeah um bob peter tulip one of the researchers at the reserve bank of australia believes that the best test for identifying whether a housing bubble exists

is to look for discrepancies between the user cost of housing, that is the approach that James Paterba said should be used for valuing housing, which looks at the cost of owning a home. You should look at the discrepancy between that and the cost of renting or the rental yield. And he believes that housing is in a bubble when the rental yield is much lower than the user cost. What do you think of Peter Tulip's idea?

I have to read his paper, but what strikes me in the United States, you can get from the Bureau of Labor Statistics the rent equivalent of owner-occupied housing, or you can get rents of apartments by city. And you can compare that path of rents with the path of prices. Now, if you have the model that home prices are driven by demand for housing, then you would expect those two series to move somewhat together. But in fact, rents are so much more stable than home prices. So it can't be that people are predicting. The rents are just very trendy comparatively. And home prices will double and fall in half.

Now, it could be that people are processing information about future rent changes that didn't happen and capitalizing that into home prices. But just looking at the figure, it just doesn't look right. Rents are so predictable and slow. Why would home prices be jumping up and down? And the actual past movements in home prices didn't predict changes in rents of any magnitude similar so far. So it... Also, do you think people are even looking, most people, when they buy a house,

it's for emotional family, it's a time in life when it's time to buy a house. Yeah. They're not thinking like economists imagine. Tulip's famous for arguing that Australia is not in a housing bubble, according to this model. 2014, they actually argued that housing was undervalued.

The last time he thinks we may have been in a bubble was 2003, 2004. Well, they've been correcting down in the last couple of years. That's right, yeah. I'll give you a quick rundown of the situation in a moment. I want to work out, I'm really interested in how housing bubbles start. There's two broad ways of thinking about this, Bob. One is your way. So in Chapter 12 of Animal Spirits, the book you co-authored with George Akerlof, you argue

that real estate cycles, including the extreme one we saw in the 2000s, should primarily be understood as being driven by animal spirits. And in this view, debt is kind of a sideshow. And then the second view, which I suppose you could say was most forcefully advanced by Atif Min and Amir Sufi and their excellent book, House of Debt, which first came out in 2014, they kind of placed debt at the center of their view of housing bubbles.

They made an argument that it's credit that causes housing bubbles to be triggered into existence. Which view do you think is the correct one? And do you see any truth in their view that it's credit that drives housing bubbles and animal spirits follow? I think that they had an interesting book, but it's hard to unravel cause and effect. When you see that lenders were lowering their lending standards just before the world financial crisis, you have to ask why were they lowering their standards? Why did the regulators allow them to? I think it had to do with these people believing that it wasn't a bubble. They're thinking that they can't imagine that home prices would actually fall. So they were weakening their standards

of inspection of borrowers. I was at a conference, I don't remember, like 2006, just before the financial crisis, and I talked to someone who was involved as a lender, and he confided to me that, well, I'm doing this because everyone else is doing this. And I won't be blamed for not anticipating a big correction if it comes, because nobody else will have.

And I don't really feel that it's particularly coming. I just feel the need to get my... Maybe he wasn't talking so much about himself, but his thoughts he had and that he attributed to others. I have to keep my career moving ahead. And I'm in this industry, and let's do it. So they become increasingly complacent about lending standards and they were giving higher down payments because they thought at some level

intuitively they thought well home prices are going to be 10-20 percent higher before you know it so why should I demand 80 percent down 20 percent down payment. Yeah. So it is, I've had them tell this to me, myself, I've heard this directly from, it's the atmosphere. Imagine yourself as a young professional running a mortgage company

and are you going to go out of business at this time? You're kind of forced by competitive pressures to match the terms that others are offering. So I don't think there's a clear distinction between credit and demand changes causing a housing boom. Yeah.

Well, the way they explained it in their book, and I have to admit, I haven't read all the papers yet, all of their academic articles, so there's probably some more sophisticated argumentation here. But they argue that they shut down the housing bubble channel by looking at elastic cities where the price rise wasn't so aggressive.

And they find that credit was flowing to the elastic cities where the price rise wasn't so aggressive. And they find that credit was flowing to the elastic cities and the inelastic cities. The price rises were more aggressive in the inelastic cities. And so they say that kind of shuts down the bubble channel. And in doing that, they're almost equating the price rises in the inelastic cities with bubbles. But I would look at the price rises in the elastic cities and say, sure, they're not as impressive, but I would probably still call that a bubble. So I wasn't... It doesn't seem to me that it takes away from the view

that these movements are a bubble. Yeah. I think what you mean, an inelastic city is one that's got mountains all around it. Exactly. There's just no place to build anymore. Yeah. Or a city that has very draconian zoning restrictions. Yes.

And they won't let you build. And so there are studies that have shown that the inelastics, it's not just theirs, that inelastic cities are more bubbly than elastic. Yeah, Ed Glazer's work. Right. Yeah. And so, but that doesn't, to me, tell you where the demand shift is coming from, whether it's rational or not.

Yeah. So, maybe we could summarize housing bubbles with the little slogan credit and crowds okay is that a slogan for a mortgage company um bob something really interesting in terms of the expectations or the animal spirits in housing bubbles is this distinction between short-term speculation and long-term speculation. And a lot of people have told me that speculation in Australian housing isn't so concerning at the moment

because the most concerning speculation is the short-term speculation. What do you think about that i thought you were going to bring up hong kong and and how the hong kong market uh is even more highly priced than australian yeah and you might think with these riots would be collapsing soon and shifting demand even more toward Australia. If that's short term, you haven't brought it up. No, we can discuss it. It's long term speculators are people who are more often likely to be value investors, I think. Things like momentum, at least in the stock market, are thought to be, by the research, six-month or one-year speculations.

Value investing talks more about long-term. So I'm thinking, I don't know what you're going to ask about the Australian market. I'm not an expert on it. But I'm thinking that the Asian demand is very much a powerful narrative for Australia. But what I'm getting at, I suppose, is that long-term speculation plays a definite role in the formation of bubbles. I mean, that was sort of the whole topic of Chapter 12 of Keynes' general theory, wasn't it? Right, the state of long-term expectations. And that's where the word animal spirits appears.

So he said that people have no precise way of forming long-term expectations, but it's the dominant factor. Therefore, it's led by animal spirits. It's just a hunch that people have at some time that these are good times to invest. Unfortunately, we all get the same hunch at the same time. And nobody can prove us wrong. And another thing is that stock market advisors will sometimes not correct you out of your hunch because they don't want to throw a wet blanket on your enthusiasm,

which yields customers. Sandeel Moolenathan has a study where he sent in actors to financial advisors. And one actor, the actor would appear very conservative and the other actor, or another time the same actor,

would appear extremely risk tolerant. And he found that the advisors took that as taste and invested into that without doing any counseling about maybe you don't rethink your attitudes toward risk. Let me give you an update on the Australian housing market. I'll give you some quantitative evidence first, a brief history of price rises, and then I'll tell you about some of the atmosphere or the speculation that I've observed.

And I only started paying attention to this in the last couple of years. I'm too young. When prices were falling. Yeah, that's right. Although I did start thinking about it just before they fell. But anyway, you'll still get a sense for what it's like down under. So, a history of price rises in Australia. Now, these are all nominal prices. to 2004 prices rose 133 percent in sydney 123 in melbourne and 109 nationally i'm just gonna what was the overall inflation rate at the time it wasn't that high no it wasn't very high no yeah it's been a low inflation environment for the last couple couple decades um and and i've i've just got

sydney melbourne and nationally here syd. Sydney and Melbourne are the two most important cities. They're the largest chunk of the housing market. And they're really where the bubble has occurred. So that was 1995 to 2004. Big run up. It eased off a little bit. The central bank started leaning against the wind around 2004. So from 2004 to 2008, prices only rose 7.8% in Sydney, 38.3% in Melbourne and 27% nationally.

2008 to 2012, the market went sideways and we kind of kept it on life support. We didn't have the big crash that a lot of other countries who had experienced previous run-ups in house prices had. There are multiple reasons offered for this. Our government came in with very aggressive fiscal stimulus, which proved to be crucial. We also had Chinese demand for our resources, a lot of wealth washing into the country that way. And ultimately, we avoided recession, which was quite important. I've also heard Jeremy Grantham offer the opinion that because of the prevalence of variable rate mortgages in Australia, that protected the bubble, as it did in the UK as well. So Bob, I know that the standard in the US is like a fixed mortgage rate. In Australia, about 84% of our mortgages are variable rate. But anyway,

the bubble was kind of protected. Then from 2012 to 2017, prices rose 74.7% in Sydney 57.8% in Melbourne and 40.8% nationally until these recent falls so from July 2017 to May 2019 prices fell 14.9% in Sydney 11.1% in Melbourne and 8.4% nationally and they've kind of

they've modestly rebounded in the last two months. And my email inbox has been inundated with emails from property investment gurus saying the boom is back on. So people think that it was purely a, you know, a mild mid-cycle correction. But I normally describe Australia's bubble as beginning in 1998 because that was when the right of centre government at the time introduced some tax policy changes. We had a capital gains tax discount. And so I call the first phase of the

bubble the Howard phase after the then Prime Minister John Howard. So the Howard phase went from about 1998 to 2008. And then I call the second phase from 2012 to 2017, the Stevens phase, after the then governor of the Reserve Bank, Glenn Stevens, who started slashing interest rates in earnest beginning in December 2011. But what's interesting, there's a different flavor in each of the two phases. The flavor in the first phase seemed to be a lot more about short-term speculation. It was almost as if people were overreacting to the fundamentals.

They weren't sure how long they would last. And CoreLogic data shows that 20.4% of property sales in the 2000s were for flipped homes. So in the 2000s, of all the property sales, 20.4% were properties that were flipped. So that is bought and sold within 24 months of the original purchase. That had fallen back down to about 7% in 2017. So while the flavor of the second phase, the Stevens phase, the later phase of the bubble

was more long-term speculation. And there was almost this mystical quality to it. The idea had really taken hold that housing is the best investment over the long term. You only have to look at the last two decades of data, which is all we really have. You don't have a century-long series. Well, we do. So the Australian Bureau of Statistics only began publishing our national index in 1986, but Nigel Stapleton built an index back to 1890. I haven't seen it.

Yeah, I'll send it to you. People just don't really use it. But this long-term speculation set in in the second phase of the bubble. And Bob, by around 2015, we had over 40% of mortgages originated being interest only, with about 70% of those going to investors. And on the latest tax data, there are about 1.3 million Australians who have at least one negatively geared investment property. So, in other words, they're losing money on the carry. Most of them will still be in a net worse position because you get some money back in tax savings,

but it's not enough to offset the the uh the losses from the property and that's in a nation of only 25 million people there's over 300 000 australians have two or more negatively geared investment properties and to me that only really make like losing money in an investment only really makes sense if you think you're going to make it back on the capital appreciation right um but so just quickly, some price to rent ratios. So the price to rent ratio for two-bedroom units peaked at about 27. Two-bedroom units, that's like condos or apartments, peaked at about 27. So that's in 2017.

Yeah. It's 27 in Sydney and Melbourne. Currently, it's around 24 in Sydney and 26 in Melbourne. And the price to rent ratio for three-bedroom houses peaked at about 50 for Sydney and 44 for Melbourne in around 2017. Currently, each city is around 40. So, that's some of the quantitative data. Now, I try to go to about one property investor seminar per month. You're really into this. Oh, yeah. I should have done that.

It's incredible. It's sort of like being an anthropologist. It's like me in this football stadium. Exactly. Looking at the enthusiasm. And they probably played loud, exciting music, stimulating music, motivational speakers. Oh, exactly. Well, it's interesting you mentioned that. So the one that is the most kind of lurid, the one I like going to the most is I Love Real

Estate. And the guru or the inspirational leader is Dymphna Beholt, who teaches you how to replace your income with real estate and become a millionaire like she did. This is current. Current, yeah. And she was mentored by Tony Robbins. And when you go to these conferences, they have inspirational music. They bring examples of people up onto stage who've achieved great wealth through real estate. And they always begin with, it's always about some sort of inner journey and taking action and overcoming fear.

Right. And you always start with mapping out the life you want and they kind of scare you with statistics on how a lot of Australians don't have enough money for retirement and they'll get you to calculate how much you need and then the life you want to live. And someone wrote a really interesting paper on Australian property investor seminars and how they use the narrative or the monomyth of the hero's journey with the investment guru being kind of like Campbell's, you know, like the mentor. So, those are fascinating. I was really disappointed. I missed Dimfner Beholtz weekend conference a couple of weeks ago, but fortunately,

she put it out as a podcast, Bob. I'll watch it then. Yeah, I'll send it to you. At about 25 minutes, this is what she says. So, this was a couple of weekends ago. She says, Sydney's median house price at the end of last year was just on a million dollars. And the average growth in Sydney, as at the end of last year for the previous 25 years, was 7.6%. And then she asks the crowd, what would be the case if we had for the next 25 years, the same level of growth in Sydney that we've had for the past 25 years? And people are kind of murmuring or shouting out answers.

Do you think the median house price, what do you think the median house price would be in 25 years' time? $2 million? $3 million? $5 million? Try $6.349 million, she kind of shouts out. And I just thought it was hilarious because it's truly this idea that trees grow to the sky. And if you say you assume 3% income growth, which is actually higher than what we have in Australia at the moment, a median house price of $6.349 million in Sydney would imply a price to income ratio of 26x um anyway my my final my final australia update which i can't find a fun kind of amazing is we have this huge auction culture and auctions are an amazing place for

people to gather the kind of like these crucibles of mimetic desire when not only kind of as a yeah not only not only are people bidding yeah not only are people bidding against each other, but a lot of people come out just to watch. I went to one in Camperdown. I would do that. Yeah, see, that's a crowd a couple of weekends ago for an upper-middle-class home in Sydney's inner west, about 60 people.

During the height of the last boom, the percentage of sales that occurred via auction in Sydney and Melbourne were around 45% to 50%, which I just find wild. And I don't have any data on international comparisons, but I know from what people tell me that that's quite unique internationally. Anyway, Australians are obsessed with their housing. I'll give you two more final examples. According to a recent HSBC study, we spend about 2.5 hours a week researching or thinking about property. And some of our most popular television is about property. For example, on the 17th of August, 2003, three million Australians tuned in to watch a show called The Block, where you do up and then flip homes,

and the winning couple are the ones who sell for the greatest profit. And that was the largest television audience of the year and the largest altogether since the Sydney 2000 Olympics. But The Block remains a very, it still continues. It remains a very popular show. So anyway, Bob. So why, is there some patriotic element? Why would Australians be different from other?

Why would we be so obsessed with housing? See, I have a theory about Australian housing that I don't know. Can I try this out on you? Yeah, go for it. It goes back to the movie On the Beach. Do you know this movie? Yes. From about 50 years ago.

Can you just tell people about it? It was taking place in Australia. It was a movie about the Third World War in which the other countries annihilate each other with nuclear weapons, and it becomes hazard, impossible to live anywhere but Australia. Okay. You didn't see this movie? But unfortunately...

I know the movie. I haven't seen it, but... I haven't seen it in 50 years but i still remember it it affected my family my father wanted to move to australia yeah because it seems like the safest or new zealand it's just so far away from anything else and and uh it's it's a civilized country and what's what's not to like about it? Yeah. So you have the sense that...

Now, actually, I think On the Beach ended up with the Australians dying eventually. A very sad movie. But at least they lived longer than anybody else. So isn't that a factor that people think that Australia is different because of its, well, first of all, it's a nice country, but also just that it's apart from everybody else. It's safe from the World War Three, relatively. Yeah, it's interesting. So two years ago, I had a guy on the podcast called John Flavell, who was the then CEO of Mortgage Choice, a mortgage-broking company listed on the Australian Stock Exchange. And I was presenting to him the idea that Australia might be experiencing a bubble.

This is actually before prices started turning down. And one of his answers were that, you know, Sydney is a lovely place to live. Look around you. Look outside. Look at the weather. People are always going to want to move here. But the subtext was kind of like you know are you being unpatriotic are you bagging out sydney you're saying people

don't want to live here because assuming that house prices are just you know a function of supply and demand um right so yeah there are there is some national pride wrapped up in it we also have you guys have the american dream the home with the white picket fence. We have the Australian dream as well. There's always been this culture of home ownership going back to probably even before Bob Menzies and the 1960s. So, Bob, given my lengthy update to you on the Australian housing market, it probably is a housing bubble. Am I wrong? Yeah, it doesn't mean it will end soon. And I think that there might be, I think of this Hong Kong story

as suggesting new heights for Sydney and a drop in Hong Kong. This is the flight to safety, people trying to get their money out of Hong Kong. That's right. Doesn't that sound like a short-run narrative anyway? Yeah. Until we see what happens in Hong Kong. But yeah, the question is what triggers the turning point? And that's a hard one.

I think it's generally a change in narrative. If I look at the turning point in the United States after 2006 and on into the financial crisis, there was a change in narrative. The term housing bubble first became common then. If you look at Google Trend searches, people suddenly started searching for housing bubble first became common then. If you look at Google Trends searches, people suddenly started searching for housing bubble around 2005. The talk shifted. The news magazines in 2005 started talking about housing bubble. But it took two more or several more, well, it took until 2012 for the market to bottom out. So what they did is started a narrative. It started going viral.

This is what I describe in my new book. Housing narratives can grow slowly over years and then eventually become dominant. So I think the housing bubble story would have been, if you brought it up in 2002, if you could go back in a time machine, most people would stop and say, what's this? A housing bubble? It didn't

have their attention and it didn't have any embellishment. But that came and was talked about increasingly. So I would say that was a narrative epidemic that came. So the same thing. Now, why hasn't it happened? Australia is in many ways similar to the United States.

In fact, the trends in house prices that you gave sound similar to the U.S. You said from 2012 to 2017. Yes. Well, the U.S. housing market was doing exactly the same going up rapidly. What's special about 2012? I'm trying to think. Well, in Australia, we started cutting interest rates in December 2011. Well, the U.S. had already pushed them down to zero. So that's not the same.

But the housing markets look the same. You know, if you plot London, England, and Boston, Massachusetts, they look surprisingly similar. Yeah. So it seems to me that world real estate culture, or at least not so word, for English-speaking countries, Anglo-Saxon countries. We're like all one country. We have one story. We read each other and talk to each other. So there was a story that emphasized

the inevitability of home price increases that weakened after 2006 and then came back. So we need more help from sociologists to help us understand these things. So I think there's two phases to a housing bust. There's a tightening of credit.

And the down cycle we just had in Australia was triggered by regulators. It wasn't interest rate rises, it was regulators tightening credit. What year are you talking about? Just the last two years? Yeah, the one that started in 2017. So that was caused by regulators. But the second phase to a housing bust seems to be when expectations flip or faith in the market is kind of shattered. And we never reached that point in Australia.

And I don't want to say that there's a major recovery underway just on two months of data. It could be a dead cat bounce, as they say. But it's looking more likely. And I think that'll be because expectations, they're intact. Didn't the biggest price decreases occur more like one year ago? And the creative decrease has been slowing down for a year or so? Correct.

So this is the way house price behaves. So you can probably extrapolate, not with 100% confidence, with 50% confidence that home prices in Australia will be higher in another year. Gotcha. Going all the way back to that paper you wrote with Chip Case in the 80s. Right, right. Yeah. The question for Australia is how big is this bubble? You know, Bob, we have the second highest household debt to GDP ratio in the world after Switzerland. But there's a lot of debate around how much of a bubble it is. On the one hand, we had Ray Dalio speaking with the Australian media recently,

calling it a mini bubble. But on the other hand, others have called it, you know, one of the biggest housing bubbles of all time. I know you're not so familiar with the market but down here but do you have an opinion on that like how how just how bubbly does this sound to you i'm sorry you're talking about what year is now uh it's right in the last so the the last phase sort of the 2012 to 2017 phase but even even continuing, like many people would still say, even though we've had some declines, it's still classified as a bubble. But some people like Ray Dalio say it's a mini bubble. Other people say it's one of the as the earlier one that you described preceding 2007. I'm thinking of the U.S., which has a very similar pattern. It doesn't seem as far out as it did before the financial crisis. And regulators have been... I don't know about Australia, in the U.S. regulators have been

more tough. Yeah. So it doesn't, real home prices corrected for inflation have not surpassed, overall for the U.S. have not surpassed the peak of 2006. So it, but that might mean it's just, you don't hear a lot of talk do you about it being crazy? maybe you do in Australia it doesn't seem to me as

much of the talk of the town as it was before 2006 so I tend to want to forecast these things by my judgment of the psychology back in 2003, everybody was talking about home prices. I took a taxi in Phoenix, Arizona, and the taxi driver started talking about home prices to me and pointing out what things sold for. I hadn't told him that I was interested in home prices. He just was a talkative guy. On the airplane coming back from Phoenix,

I heard people in the row behind me talking about home prices. It just doesn't happen normally. So it was really big back then when it was new and exciting. I don't know what it's like. Well, I remember reading, I think it was in Irrational Exuberance, you spoke about a game you used to like to play was go out to dinner and see if you can hear anyone at the adjacent tables talking about housing. Once I read that, I started playing that game as well. And you do hear people talking about it, although not as much during the last two years when the price falls have been happening. Yeah, the price falls, they kill a, they kill the, uh, enthusiasm. That's right.

Yeah. What's so interesting about housing busts is because of this inertia and the momentum of expectations, they can be really drawn out. And I remember in, uh, Rogoff and Reinhardt's book you mentioned earlier, uh, this time is different. They say that the, the average duration of the major housing busts they studied, peak to trough, was six years, which is a lot longer than stock market crashes. So, in that sense, a bubble is sort of an altogether misleading metaphor for a housing bacchanalia because they increase for so long and then they kind of deflate like a long sigh for a very long time as

well have you thought of any alternative metaphors we could use well i was thinking of the uh the metaphor the word that was used during the tulip mania in dutch do you speak dutch i know the word was vindhandel yes uh that means means wind trade, the wind trade. So it didn't have the thing about, it was like the wind. Yeah. It didn't say that it was going to burst, but it did imply that it was crazy. Yeah.

You did mention that the Hong Kong narrative could be something that gives new life to the Australian housing bubble. Have you seen any data to support that view? Or is it just your sense? That is just my sense. But it also relates to the fact that Australia is a durable democracy. Yeah.

And it must sound awfully inviting to Hong Kongers. And the news about Hong Kongers coming to Australia strengthens the feeling about Australian, including within Australia. So it seems to me that that is part of the story. And I mentioned, I grew up with the thought of moving to Australia with my parents. It was there. They told me that we might move. I was thinking that I would end up in Australia. But for some reason, they never did it. That was back in the years when there was a nuclear fear. Right. Have you been here before?

Yeah, I've been one or two times. Yeah, I had a great time. Nice. It felt like California to me. I don't know why. I felt like I was in California. I see that. Yeah.

Yeah. Maybe not San Francisco. Melbourne is often compared to San Francisco, but Sydney might be something else. More broadly, just finally on this idea of narratives, what separates viral narratives from the ones that fizzle out? What makes for a good narrative? That is a deep question, a difficult question. from the ones that fizzle out. What makes for a good narrative?

That is a deep question, a difficult question. In the show business, they wonder that all the time. They'll put millions on a movie or they'll sign a contract with a performer or a singer. They want to know whether this person... But, you know, unfortunately, there's some je ne sais quoi about successful narratives or successful songs. What is it about that?

You know, you can... If you play any song that's reasonably well-performed, play it enough, you might start to like it, but nobody does that. So it's something social that... There's some creative moment. A lot of songwriters will have only one or two big successes in their lives, and they remember that they had a moment of inspiration,

but they can't say what it was that they did, and they can't do it again. I think of it like a mutation of a virus. The story is like a virus. And if you look at virology, they look at the DNA of the virus, and they'll find that a newly contagious virus is just only different by one or two atoms in a huge molecule, some mutation. So nobody understands these things. There's a lot of work to be done. And I think there will be a lot of work to understand the virality of narratives. Finally, there's a little piece of math, which I think is kind of neat, which is capable of being conveyed on a podcast. So we might as well just mention it.

And that's the rate at which contagions grow. Yeah. So I talk about mathematical epidemiology in the appendix to my book. Yeah. The canonical model is the Cormac-McKendrick model from the year 1927. It's getting close to 100 years ago. It's a differential equation model, and it divides the population into compartments. There are three compartments in this model.

The susceptibles, call that S, the infectives, call that I, and recovereds, call that R. S, as a fraction of the population, they're all, they're S plus I plus R always equals 100%. But initially, when someone, an an immigrant comes carrying a terrible disease, it's almost 100% susceptible, right?

Then the immigrant starts to mingle with the population. And at first, the rate of growth of the epidemic is enormous. But you don't see it yet because there's so few people involved. The rate of growth initially depends on the contagion rate. Some diseases are more contagious than others. AIDS is a low contagion disease, so it grows slowly, but it grows for a long time because you don't recover from it and you don't die from it for many years. So it spreads. So eventually there's a race between contagion and recovery.

So for a while the epidemic grows. Eventually it doesn't have enough susceptibles and so it falls below the recovery rate. I don't know if this will be clear or not. And then the epidemic tails off and slowly declines, asymptotic to zero. And I think that same model applies to narrative epidemics. The phrase go viral refers to memes or stories on the Internet or photographs. But they're apt in describing it as a when you say go viral that means go into an epidemic

they're describing an important model so I'm thinking that much more of what happens in history is determined by stories going viral so Julius Caesar went viral. So Julius Caesar went viral. Mao Zedong went viral. There were stories about them, and there were stories that captured people's imagination.

What's interesting with the contagion rate, if it's sufficiently high, higher than their recovery rate, the size of the population infected over time looks like this perfect sort of hump. Right, right. Which you could almost say looks like a bubble. Except it doesn't burst suddenly. Yeah. No, but there could be a fast, there are both fast and slow epidemics. So there could be a fast counter epidemic that would offset. And then the housing market might sink, but there's still the underlying growth from the old epidemic and it can come back.

So it's not a bubble in the mechanical sense. Yeah, kind of can come and go. It's a bubble in the mechanical sense. It's a war against competing epidemics. Wow. Bob, this has been utterly fascinating. I can't thank you enough for all your work and all you do and for your time. Thank you so much for joining us. My pleasure.

It was fun. Thank you so much for listening. I hope you enjoyed every bit of that interview as much as I did. One of my regrets about that conversation is I didn't have the presence of mind to raise Geoffrey Blaney's book, The Tyranny of Distance, when Bob was talking about the narrative

that Australia is this safe haven, sheltered far away from the rest of the world. It was, I had to get up at 4am Sydney time and I was frazzled. But there definitely seems to be something to this idea, this notion that Australia is this protected, stable democracy far away from the ravages of war. And I was thinking of riffing on Blaney's idea and calling this narrative the liberty of distance narrative. Over the coming weeks, I'm going to be looking for ways to test Bob's hypothesis and quantify it. And if you have any ideas, please let me know. You can find me on Twitter. My handle is at Joseph N. Walker,

or you can contact me via my website, which is www.josephnoelwalker.com. That's my full name, J-O-S-E-P-H-N-O-E-L-W-A-K-E-R.com. And you'll remember from the interview, Bob and I discussed a truckload of books and papers and other bits and pieces. You can find all those on the same website. I've put links up to everything we discussed. And finally, just before you go, you'll notice that I don't have a Patreon. I don't ask for your charity.

I didn't even scatter ads throughout this interview, despite the audience it will likely reach. All I ask is that if you enjoy what I'm doing, you share the podcast with friends or on social media, and you leave a rating and a review on iTunes. I know everybody asks, but I promise I won't tell the other podcasts. So thank you so much. Thank you for your time. Until next time. Ciao. You can go back to bed now.