WEBVTT 00:01.780 --> 00:04.020 Professor Robert Shiller: I want to start out 00:04.018 --> 00:06.168 by talking about real estate as an asset class. 00:06.170 --> 00:10.360 It's actually the biggest and most important asset class. 00:10.360 --> 00:15.460 The value of real estate in the United States today is--of real 00:15.463 --> 00:19.663 estate owned by households directly--is about twenty 00:19.661 --> 00:24.471 trillion dollars, which makes it comparable or 00:24.473 --> 00:29.873 maybe a little bit bigger than the stock market. 00:29.870 --> 00:35.990 Stocks owned directly by households are only about six 00:35.994 --> 00:38.194 trillion dollars. 00:38.190 --> 00:42.240 For a typical household, the home is the major source of 00:42.243 --> 00:44.753 wealth that they've accumulated. 00:44.750 --> 00:49.000 Of course, other stocks are held by institutions on their 00:49.003 --> 00:53.493 behalf, but in terms of direct ownership, homes are the main 00:53.485 --> 00:55.455 thing that people own. 00:55.460 --> 01:01.270 There's also commercial real estate, which is smaller than 01:01.274 --> 01:05.314 owner-occupied homes, but we own that indirectly too, 01:05.306 --> 01:07.586 as a people, through the stocks that we own 01:07.590 --> 01:10.310 and through the institutions we participate in. 01:10.310 --> 01:14.540 It's very important and it has some important 01:14.544 --> 01:20.514 financial–there are a lot of financial institutions built 01:20.510 --> 01:25.420 around dealing with the fundamental problems of real 01:25.418 --> 01:28.798 estate. I want to talk first about 01:28.798 --> 01:32.478 institutions and then move to what I think is, 01:32.481 --> 01:34.561 myself, more interesting, 01:34.560 --> 01:38.790 which is the real estate boom and the kind of fluctuations 01:38.787 --> 01:42.047 we've seen in real estate over the years. 01:42.050 --> 01:46.500 I'm going to start out by talking about commercial real 01:46.497 --> 01:51.027 estate and the kind of vehicles that we use to invest in 01:51.026 --> 01:53.246 commercial real estate. 01:53.250 --> 01:57.630 Then I want to talk about mortgages, which is the way that 01:57.634 --> 02:02.254 we finance both commercial and owner-occupied real estate. 02:02.250 --> 02:05.190 Then finally, I want to come to the real 02:05.192 --> 02:08.062 estate boom that we are recently in. 02:08.060 --> 02:17.380 02:17.379 --> 02:24.429 Let me start by--the way--the kind of institution that you 02:24.431 --> 02:31.361 probably know relatively little about--or commercial real 02:31.359 --> 02:35.219 estate. Commercial real estate--that 02:35.220 --> 02:40.400 means real estate owned not by individual households but by 02:40.399 --> 02:47.219 businesses. The institution I wanted to 02:47.222 --> 02:55.272 talk to you about first is called a DPP, 02:55.272 --> 03:05.042 a Direct Participation Program, which has been traditionally 03:05.040 --> 03:10.840 the single most important form of holding of commercial real 03:10.837 --> 03:13.267 estate. When you drive along and you 03:13.266 --> 03:16.106 see all these commercial buildings, you might wonder who 03:16.108 --> 03:18.988 owns them. Well, sometimes they're owned 03:18.993 --> 03:22.513 by corporations, but I think the more important 03:22.505 --> 03:28.725 institution is the DPP, which is a financial vehicle 03:28.729 --> 03:37.359 that owns commercial real estate on behalf of investors. 03:37.360 --> 03:53.850 The most important DPP is called a limited partnership or 03:53.847 --> 03:57.147 LP. There's a very simple reason 03:57.147 --> 04:01.187 why real estate tends to be held in limited partnerships rather 04:01.193 --> 04:04.913 than corporations and that reason is the corporate profits 04:04.912 --> 04:09.922 tax. Corporations are taxed on their 04:09.916 --> 04:13.616 profits and DPPs are not. 04:13.620 --> 04:18.700 You want, if you are setting up an organization to hold real 04:18.699 --> 04:24.909 estate, you want to do it, if you can, as a DPP because 04:24.910 --> 04:29.660 you don't want to pay those taxes. 04:29.660 --> 04:34.610 Whenever possible, an ownership vehicle for 04:34.611 --> 04:40.861 commercial real estate will have the form of a DPP. 04:40.860 --> 04:48.180 A limited partnership is one kind of DPP and it has--it's not 04:48.181 --> 04:52.941 a corporation, so it's a partnership. 04:52.940 --> 04:56.000 The simplest kind of partnership would be if several 04:56.000 --> 04:58.640 of you got together and formed a business. 04:58.639 --> 05:02.529 In a normal--in a simple partnership, the partnership 05:02.527 --> 05:06.787 would not be taxed because it's you doing business just as 05:06.788 --> 05:11.048 partners, so you are taxed but not the 05:11.051 --> 05:14.161 partnership. The problem with partnerships, 05:14.163 --> 05:17.333 generally, has been that they don't have limited liability. 05:17.329 --> 05:22.979 A corporation is an entity that could be sued or could lose more 05:22.978 --> 05:27.188 money than it's worth, but the value of a corporation 05:27.193 --> 05:31.533 can never fall below zero to the investors because the investors 05:31.526 --> 05:35.236 are not liable for the mistakes of the corporation. 05:35.240 --> 05:38.330 If you buy stock in a company the most you can lose is the 05:38.334 --> 05:40.564 money you put up, so that's called limited 05:40.560 --> 05:43.320 liability. If you take part in a 05:43.324 --> 05:48.964 partnership you are individually liable for the debts of the 05:48.957 --> 05:51.807 corporation. That's a problem with the 05:51.805 --> 05:55.255 partnership structure because you could join a partnership and 05:55.259 --> 05:58.599 the partnership does something awful and loses more than you 05:58.599 --> 06:02.109 put into it and they can come after you for those losses. 06:02.110 --> 06:05.680 There is something, however, called a limited 06:05.676 --> 06:10.536 partnership that has two kinds of partners: a general partner 06:10.539 --> 06:13.619 and a limited partner--or usually, 06:13.620 --> 06:15.450 many limited partners. 06:15.449 --> 06:19.299 The general partner takes on the liability; 06:19.300 --> 06:23.960 the limited partners don't have liability. 06:23.959 --> 06:26.439 So typically, real estate is held in a 06:26.443 --> 06:27.923 limited partnership. 06:27.920 --> 06:29.730 It's limited because–well, 06:29.731 --> 06:33.001 they want to put it in a limited partnership because they 06:33.003 --> 06:36.223 don't--it's not easy to sell other people on joining the 06:36.217 --> 06:39.607 partnership if they could get unlimited liability for doing 06:39.607 --> 06:43.087 so. There is a general partner who 06:43.087 --> 06:47.527 takes on the liability and the limited partners, 06:47.533 --> 06:51.703 who are many, are the participants who do not 06:51.695 --> 06:54.055 share the liability. 06:54.060 --> 06:57.940 The general partner is typically the organizer of the 06:57.944 --> 07:01.294 partnership. Someone who buys a fifty-story 07:01.290 --> 07:05.660 building downtown and then, well, arranges to buy and gets 07:05.662 --> 07:09.882 partners--limited partners--to join in financing it; 07:09.880 --> 07:11.410 that's the arrangement. 07:11.410 --> 07:16.700 You have a general partner, then limited partners, 07:16.703 --> 07:20.163 and you don't hear about DPPs. 07:20.160 --> 07:23.590 I'm telling you something that you probably haven't heard a lot 07:23.587 --> 07:26.897 about. This is not commonly advertised 07:26.903 --> 07:31.633 or described--just like hedge funds are not commonly 07:31.630 --> 07:35.890 advertised and described--because it is thought 07:35.893 --> 07:41.083 that DPPs are suitable only for wealthy and sophisticated 07:41.084 --> 07:44.914 investors. They're complicated, 07:44.911 --> 07:51.441 so the general rule has been that only accredited investors 07:51.442 --> 07:54.822 should participate in them. 07:54.819 --> 08:00.429 I mentioned this before--in the U.S. 08:00.430 --> 08:03.360 and in other countries as well, they're a similar thing. 08:03.360 --> 08:08.550 We defined an accredited investor as someone who can 08:08.551 --> 08:14.151 participate in a DPP or other sophisticated programs. 08:14.149 --> 08:21.629 The definition is in Regulation D, which defines an accredited 08:21.630 --> 08:24.760 investor. For many years now, 08:24.760 --> 08:30.100 to qualify as an accredited investor, you have to have one 08:30.100 --> 08:35.720 million dollars in wealth or income in excess of $200,000 or, 08:35.722 --> 08:40.222 if you're married, $300,000 for the couple. 08:40.220 --> 08:43.820 In 2006--I mentioned this before--in 2006, 08:43.824 --> 08:49.014 the SEC proposed raising the definition to make it harder to 08:49.012 --> 08:53.252 be an accredited investor, but they haven't done that yet; 08:53.250 --> 08:58.540 so, it remains at one million dollars to do it. 08:58.539 --> 09:01.579 Nonetheless, DPPs don't advertise. 09:01.580 --> 09:04.520 You see mutual fund advertisements everywhere. 09:04.519 --> 09:08.079 You don't see advertisements for participation in commercial 09:08.084 --> 09:11.774 real estate like this because the government would be on their 09:11.769 --> 09:13.279 backs if they did it. 09:13.279 --> 09:16.059 Since it's available only to accredited investors, 09:16.058 --> 09:19.288 you can't be advertising because everyone would see it; 09:19.289 --> 09:24.639 that's why the financing of a lot of this real estate is 09:24.639 --> 09:29.799 something of a mystery, because they can't talk openly 09:29.795 --> 09:34.725 about it. These DPPs go back a long time 09:34.729 --> 09:42.679 but there began to be complaints about them because people said, 09:42.679 --> 09:45.429 well why is it, because I'm not an accredited 09:45.426 --> 09:49.226 investor, I can't get into real estate like these other people 09:49.233 --> 09:51.593 do? Why isn't there something 09:51.586 --> 09:56.336 offered to me that's like a DPP that's available to everyone? 09:56.340 --> 09:59.680 Another way of putting it, the government is effectively 09:59.675 --> 10:03.005 saying that unaccredited investors are free to invest in 10:03.010 --> 10:06.710 corporations that invest in real estate and they're subject to 10:06.709 --> 10:08.649 the corporate profits tax. 10:08.649 --> 10:12.949 Wealthy people have the choice of getting around the corporate 10:12.952 --> 10:15.122 profits tax. So, in a sense, 10:15.121 --> 10:17.801 the tax structure was regressive. 10:17.799 --> 10:19.749 It was saying, we're going to have lower taxes 10:19.751 --> 10:21.531 on rich people than on ordinary people; 10:21.529 --> 10:28.319 that didn't seem fair at all, so there was a complaint aired 10:28.321 --> 10:31.891 about DPPs in the late 1950s. 10:31.889 --> 10:34.599 People said, let's change it, 10:34.598 --> 10:40.788 let's make it so that everybody can have something like a DPP. 10:40.789 --> 10:49.459 Congress finally acted and it was in the year 1960 that 10:49.457 --> 10:58.127 Congress defined a new investment vehicle called a Real 10:58.125 --> 11:08.475 Estate Investment Trust; this is for everyone. 11:08.480 --> 11:11.610 A Real Estate Investment Trust is for small investors, 11:11.611 --> 11:14.391 although wealthy, big investors can invest in it 11:14.388 --> 11:20.098 also. So, they had to make a 11:20.099 --> 11:26.829 distinction. These are called REITs, 11:26.827 --> 11:31.767 Real Estate Investment Trusts. 11:31.769 --> 11:34.239 Congress had to make a distinction between these and 11:34.236 --> 11:37.276 corporations and it's kind of a subtle distinction because there 11:37.282 --> 11:39.702 are lots of corporations that own real estate. 11:39.700 --> 11:43.220 Like, for example, Wal-Mart might want to--they 11:43.224 --> 11:45.374 pay corporate profits tax. 11:45.370 --> 11:48.630 After 19--I don't know if Wal-Mart--was it around in 1960? 11:48.630 --> 11:53.160 I don't know. Let's say it was. 11:53.159 --> 11:57.059 Wal-Mart, after the 1960 Act of Congress, would say, 11:57.055 --> 12:00.335 hey we're a real estate investment trust, 12:00.340 --> 12:04.120 we own real estate--all these stores--but that's not what the 12:04.121 --> 12:05.761 intent of this bill was. 12:05.759 --> 12:09.079 They wanted REITs to be companies that just owned real 12:09.084 --> 12:11.974 estate and Wal-Mart is primarily a retailer. 12:11.970 --> 12:23.260 They specified that 75% of assets must be real estate and 12:23.255 --> 12:34.735 75% of income must be real estate income--so that would be 12:34.743 --> 12:39.583 ruling out Wal-Mart. 12:39.580 --> 12:47.420 And 95% of income must be paid out--they can't retain earnings. 12:47.420 --> 12:53.490 12:53.490 --> 12:54.880 That limits it further. 12:54.879 --> 12:57.559 They're supposed to be like a pass through vehicle--they're 12:57.560 --> 13:00.060 owning real estate on your behalf, so they shouldn't be 13:00.056 --> 13:01.116 retaining earnings. 13:01.120 --> 13:05.820 Also, they had to be long-term holders; 13:05.820 --> 13:13.950 it had to be less than 30% of income from sales of properties 13:13.950 --> 13:21.540 less than four years--less than–no more than 30% of 13:21.538 --> 13:28.308 their income from sale of properties had to be from 13:28.313 --> 13:34.143 properties held less than four years. 13:34.140 --> 13:36.780 They didn't want flippers; they didn't want the company 13:36.780 --> 13:39.710 that's speculating in real estate, they want it to be a 13:39.712 --> 13:41.072 holder of real estate. 13:41.070 --> 13:49.000 Real Estate Investment Trusts became very important in three 13:48.995 --> 13:53.765 waves. One--the first wave of REIT 13:53.771 --> 14:01.861 growth occurred right after Congress passed the 1960 bill. 14:01.860 --> 14:06.630 The first wave was in the 1960s and, at that time, 14:06.633 --> 14:11.993 Congress had limits--state governments had limits on the 14:11.992 --> 14:17.062 interest that savings banks could pay people on their 14:17.058 --> 14:21.508 accounts. So, a lot of people switched 14:21.512 --> 14:26.222 from savings accounts to REITs--that's called 14:26.215 --> 14:28.455 disintermediation. 14:28.460 --> 14:33.510 An intermediary is a bank, so when they pull out of banks 14:33.509 --> 14:39.099 they were disintermediating and going from banks into REITs. 14:39.100 --> 14:41.330 Although, in some sense, it wasn't really 14:41.332 --> 14:44.682 disintermediation because you could say a REIT is a different 14:44.680 --> 14:48.420 kind of intermediary between the individual and the investment. 14:48.419 --> 14:55.219 The second boom in REITs occurred after 1986. 14:55.220 --> 15:00.660 The Tax Reform Act of 1986 made DPPs much less valuable to 15:00.663 --> 15:05.823 investors, and so a lot of wealthy people switched from 15:05.820 --> 15:09.060 DPPs to REITs. Before 1986, 15:09.063 --> 15:15.923 the tax law allowed use of DPPs as a tax loss device. 15:15.919 --> 15:19.189 People would invest in buildings solely for tax 15:19.190 --> 15:23.390 purposes because you could write off the depreciation on the 15:23.385 --> 15:26.545 building, so people were cynically 15:26.547 --> 15:30.087 setting up DPPs as tax shelters only. 15:30.090 --> 15:32.790 Congress said, finally--I think wisely--in 15:32.786 --> 15:36.336 1986, that we don't want to create rules that encourage 15:36.338 --> 15:40.678 people to do a different sort of business just to evade taxes. 15:40.679 --> 15:45.879 So, they made a--they said that losses that--depreciation 15:45.880 --> 15:50.060 that--In 1986, the Tax Reform Act of 1986 said 15:50.059 --> 15:55.909 that depreciation on structures in DPPs is called a passive loss 15:55.910 --> 16:00.740 and can be used to offset only passive income, 16:00.740 --> 16:04.420 which comes from something like another DPP. 16:04.419 --> 16:07.119 So it eliminated the tax advantage. 16:07.120 --> 16:11.780 If they didn't have a particular tax advantage to 16:11.782 --> 16:14.602 DPPs, they went into REITs. 16:14.600 --> 16:19.890 The third REIT boom was in the 1990s and I think this third 16:19.892 --> 16:25.462 REIT boom is different from the others because it didn't arise 16:25.457 --> 16:29.287 from any government regulation change. 16:29.289 --> 16:34.059 It arose from the beginnings of the housing bubble--the real 16:34.060 --> 16:36.810 estate bubble that we're now in. 16:36.809 --> 16:39.949 There just became a lot of enthusiasm for REITs. 16:39.950 --> 16:43.090 It's not just a bubble; it's also that REITs began to 16:43.091 --> 16:44.521 be more diversified. 16:44.519 --> 16:48.029 They have many different kinds of REITs for different kinds of 16:48.033 --> 16:51.613 real estate. It became a more interesting 16:51.613 --> 16:54.093 and diverse asset class. 16:54.090 --> 16:58.530 16:58.529 --> 17:00.689 That's what I wanted to say about commercial real estate. 17:00.690 --> 17:03.190 The two principle ways that commercial–well, 17:03.194 --> 17:04.374 there are three ways. 17:04.369 --> 17:08.049 One is commercial real estate is held by corporations in the 17:08.046 --> 17:11.036 line of business, but after that it would be DPPs 17:11.037 --> 17:14.047 and REITs. We have democratized--Now, 17:14.049 --> 17:18.659 REITs are a rapidly growing force in investing and now we 17:18.657 --> 17:23.837 have substantially democratized real estate holdings so it's not 17:23.842 --> 17:28.452 exclusively DPPs that are holding--not primarily--we have 17:28.450 --> 17:30.590 a lot of REITs now. 17:30.590 --> 17:35.150 17:35.150 --> 17:38.110 Next topic, I want to talk about mortgages. 17:38.109 --> 17:47.619 Mortgages are debts secured by property as collateral. 17:47.619 --> 17:53.309 When you mortgage a property that means that you offer the 17:53.313 --> 17:56.913 property as collateral for a loan. 17:56.910 --> 18:02.740 That means that if you fail to pay on the loan, 18:02.738 --> 18:10.338 the property is taken by the lender to satisfy your debts. 18:10.339 --> 18:13.209 It makes it possible for people to borrow who otherwise couldn't 18:13.210 --> 18:15.860 borrow. If you put a property up as 18:15.863 --> 18:20.353 collateral, then the lender knows that they can get the 18:20.349 --> 18:22.259 money back from you. 18:22.259 --> 18:34.699 The critical thing is the loan-to-value ratio, 18:34.701 --> 18:39.331 or LTV. A mortgage lender doesn't want 18:39.328 --> 18:43.748 to lend more than the property is worth because that would mean 18:43.746 --> 18:46.166 a loan-to-value ratio over one. 18:46.170 --> 18:51.070 Then if you fail to pay on the mortgage--pay off the debt--the 18:51.067 --> 18:54.597 lender can seize the property and sell it. 18:54.599 --> 18:57.439 But if the loan to value ratio is greater than one, 18:57.435 --> 19:00.095 they won't be able to get all the money back. 19:00.099 --> 19:04.669 Moreover, whenever they seize a property and try to sell it, 19:04.669 --> 19:08.309 it usually loses value anyway in the process. 19:08.309 --> 19:10.989 For example, if there's a homeowner who 19:10.987 --> 19:15.067 you've lent money to and the homeowner is defaulting on the 19:15.074 --> 19:17.514 mortgage, the homeowner might wreck the 19:17.513 --> 19:20.613 house--that happens all the time--or they might steal things 19:20.612 --> 19:22.862 from it. Who knows, they're angry and 19:22.855 --> 19:24.635 they're living in this house. 19:24.640 --> 19:27.710 They can stall you for a year; you're trying to sell the 19:27.709 --> 19:30.189 house, they hire lawyers and sue you and you've got to hire 19:30.189 --> 19:32.379 lawyers. There are lots of costs, 19:32.377 --> 19:35.307 so you want to have a loan-to-value ratio, 19:35.311 --> 19:39.321 which is sufficiently low, that the collateral will cover 19:39.318 --> 19:41.248 the value of the loan. 19:41.250 --> 19:49.720 The history of mortgages is that they have generally over 19:49.722 --> 19:58.042 time gotten more easy on loan-to-value ratio and also on 19:58.043 --> 20:02.563 maturity. The maturity of a mortgage is 20:02.555 --> 20:05.095 the date when it's paid off. 20:05.099 --> 20:16.519 If we go back to the 1920s--and I'll compare that with now--the 20:16.524 --> 20:26.474 typical mortgage had a loan-to-value ratio of 60% and a 20:26.474 --> 20:33.194 maturity of five years, often even less than that. 20:33.190 --> 20:37.450 They also had--they were--back then, in the 1920s, 20:37.448 --> 20:40.488 they were called balloon payment. 20:40.490 --> 20:45.330 What that means is that you would borrow $5,000 to buy a 20:45.327 --> 20:50.337 house and in five years and every year along the way you'd 20:50.341 --> 20:53.861 be paying interest on your mortgage. 20:53.859 --> 20:58.249 Then, in five years you had to come up with $5,000. 20:58.250 --> 21:00.990 It was interest, interest, interest until the 21:00.987 --> 21:03.037 end and then it was the $5,000. 21:03.039 --> 21:05.949 Of course, five years is too short because most people live 21:05.946 --> 21:07.846 in a house for more than five years. 21:07.849 --> 21:11.269 But, the assumption was, well, when five years comes up 21:11.272 --> 21:13.972 you refinance the mortgage; you get a new one. 21:13.970 --> 21:16.590 The banks weren't willing to lend more than five years 21:16.588 --> 21:19.378 because they didn't trust you; they thought things would 21:19.376 --> 21:20.386 change and whatever. 21:20.390 --> 21:27.470 After 1929, real estate prices fell dramatically and people 21:27.468 --> 21:29.908 became unemployed. 21:29.910 --> 21:35.560 The unemployment rate in the United States rose to 25%. 21:35.559 --> 21:40.289 Lots of people could not refinance their mortgages 21:40.294 --> 21:43.294 because they were unemployed. 21:43.289 --> 21:46.619 You go to a bank and say, I want to borrow to refinance 21:46.617 --> 21:48.587 my mortgage, which is due now. 21:48.590 --> 21:52.150 They're asking me to pay $5,000; I don't have $5,000. 21:52.150 --> 21:54.910 But the bank would say, hey you're unemployed; 21:54.910 --> 21:56.350 we can't give you a mortgage. 21:56.349 --> 21:59.229 Anyway, your loan-to-value ratio is getting pretty 21:59.234 --> 22:02.594 precarious because your house is now down 30% in value; 22:02.589 --> 22:05.899 your loan-to-value ratio, if we were to give you $5,000, 22:05.902 --> 22:07.712 would be something like 90%. 22:07.710 --> 22:10.050 They would say, no way are we going to do that; 22:10.049 --> 22:13.839 our rule says we can't lend on a LTV of higher than 60%. 22:13.839 --> 22:17.279 So, people would be turned down for the refinancing of their 22:17.278 --> 22:19.138 mortgage. What happened? 22:19.140 --> 22:20.840 They would lose the house. 22:20.839 --> 22:25.279 That happened in huge numbers in the 1930s. 22:25.279 --> 22:37.429 The 1930s was the biggest housing crisis in U.S. 22:37.434 --> 22:41.464 history. You see what the problem was: 22:41.460 --> 22:42.950 the mortgages were too short. 22:42.950 --> 22:46.930 The loan-to-value ratio--well it's not so much the loan--the 22:46.933 --> 22:50.783 maturity was short and the balloon payment at the end that 22:50.782 --> 22:55.592 they changed. In 1933, under the Roosevelt 22:55.591 --> 23:00.951 Administration, Congress created something 23:00.953 --> 23:07.883 called the Home Owners'--I mention this--it's actually 23:07.884 --> 23:15.474 relevant to right now--Home Owners' Loan Corporation, 23:15.470 --> 23:22.760 or HOLC, that was financed by the U.S. 23:22.762 --> 23:26.212 Congress. It started offering, 23:26.210 --> 23:29.670 indirectly, but started offering mortgages to all these 23:29.667 --> 23:31.777 people who couldn't refinance. 23:31.780 --> 23:36.230 It did it through banks; they gave the money to banks to 23:36.225 --> 23:39.425 make loans to people who were in trouble. 23:39.430 --> 23:42.790 They created a very important change. 23:42.789 --> 23:45.969 They said five years is too short--it's got to be 23:45.968 --> 23:48.218 longer--they said fifteen years. 23:48.220 --> 23:53.000 And get rid of this balloon payment thing at the end--that 23:53.000 --> 23:55.760 was a dumb idea. People can't pay that, 23:55.760 --> 23:58.770 if they're in any trouble, they can't come up with the 23:58.773 --> 24:00.993 whole value of the loan all at once. 24:00.990 --> 24:04.830 They demanded that the mortgages be 24:04.829 --> 24:10.249 self-amortizing--this is what came in in 1933. 24:10.250 --> 24:13.640 It was a very important change in mortgage finance. 24:13.640 --> 24:16.890 Self-amortizing means that you're not just paying the 24:16.893 --> 24:20.523 interest every year--or every month--you're paying interest 24:20.521 --> 24:23.651 plus principal. So, when the mortgage ends, 24:23.649 --> 24:26.379 you're just clear and free; you don't have to pay 24:26.378 --> 24:27.608 anything--nothing comes at the end. 24:27.609 --> 24:33.149 The HOLC said, that's a lot more sensible; 24:33.150 --> 24:35.590 so they demanded that that be done. 24:35.589 --> 24:37.829 Of course, banks would be reluctant to do it by 24:37.830 --> 24:40.950 themselves, but the government's coming with a checkbook to write 24:40.948 --> 24:44.148 the money, so they can make the mortgage, 24:44.146 --> 24:45.736 and guarantees it. 24:45.740 --> 24:49.680 The HOLC said, don't worry if they don't pay, 24:49.684 --> 24:52.394 we'll pay. So, the banks said, 24:52.392 --> 24:56.922 of course we'll do that; that created a major change in 24:56.921 --> 24:58.351 mortgage lending. 24:58.349 --> 25:00.869 This is especially relevant because--I don't know if you 25:00.867 --> 25:03.657 saw--maybe you did--in The New York Times yesterday, 25:03.660 --> 25:06.510 Alan Blinder, who is a Former Vice Chairman 25:06.505 --> 25:10.295 of the Federal Reserve Board under Greenspan and is now a 25:10.300 --> 25:13.820 Professor at Princeton, had an article saying, 25:13.817 --> 25:16.577 we need to bring back the HOLC now. 25:16.579 --> 25:21.439 In fact, our own Senator Christopher Dodd has a bill in 25:21.440 --> 25:26.390 Congress right now to bring back the HOLC, basically. 25:26.390 --> 25:30.730 He has a new name for it--I think it's called Home Equity 25:30.728 --> 25:34.678 Protection Corporation--but almost the same idea. 25:34.680 --> 25:38.710 Ideas that were common--that were new--in the 1930s are being 25:38.711 --> 25:41.201 brought back. We don't have to make the 25:41.204 --> 25:43.314 change. Well in a sense, 25:43.308 --> 25:47.578 the other thing that happened was, in 1934, 25:47.584 --> 25:53.594 Congress set up the Federal Housing Administration--FHA. 25:53.589 --> 25:58.349 The FHA is specifically aimed at guaranteeing mortgages for 25:58.345 --> 26:03.095 low-income people and it was a vision that Roosevelt had to 26:03.100 --> 26:08.430 bring more and more people into owning homes in this country. 26:08.430 --> 26:12.870 The FHA went further than the HOLC; 26:12.869 --> 26:18.349 they demanded that mortgages be twenty years and also 26:18.352 --> 26:21.922 self-amortizing. Maybe it was more of a 26:21.917 --> 26:25.857 paternalistic role of government that came in then. 26:25.859 --> 26:29.119 The government said the private sector, with these kinds of 26:29.118 --> 26:31.308 mortgages, is not doing things right; 26:31.309 --> 26:35.269 it's not planning for our future in the right way. 26:35.270 --> 26:37.550 So they made the switch. 26:37.549 --> 26:40.209 It was really the government that made the switch from 26:40.205 --> 26:42.655 five-year mortgages to the long-term mortgages. 26:42.660 --> 26:45.600 Now today, the standard mortgage, which you would 26:45.599 --> 26:49.269 probably get when you buy your first house, is not fifteen or 26:49.273 --> 26:51.113 twenty--it's thirty years. 26:51.110 --> 26:52.540 Well, they just kept going up. 26:52.539 --> 26:55.519 The thirty-year mortgage came in the early 1950s but it seems 26:55.521 --> 26:57.411 to have gotten stuck at thirty-year. 26:57.410 --> 26:59.950 That's because, well, when you buy your first 26:59.946 --> 27:03.396 house you might be twenty-five, so thirty years brings you to 27:03.404 --> 27:05.784 age fifty-five; that's close enough to 27:05.781 --> 27:08.201 retirement. I guess most people think 27:08.199 --> 27:12.259 thirty years is long enough, but that's the way mortgages go 27:12.257 --> 27:15.417 ever since. We have to--what we've seen 27:15.419 --> 27:20.389 recently--we had more government intervention back then in the 27:20.389 --> 27:22.099 mortgage industry. 27:22.099 --> 27:25.439 Since the 1990s, we've seen a proliferation of 27:25.439 --> 27:29.299 new kinds of mortgages that especially are offered to 27:29.297 --> 27:32.337 low-income people by certain lenders. 27:32.340 --> 27:40.390 27:40.390 --> 27:43.180 We've had a growth in popularity of ARMs, 27:43.179 --> 27:45.829 which are adjustable rate mortgages. 27:45.830 --> 27:52.530 27:52.529 --> 27:56.409 Adjustable rate mortgages have a long term--they might last for 27:56.413 --> 28:00.243 thirty years--but the interest rate is not fixed for the whole 28:00.235 --> 28:04.065 thirty years. A typical ARM is two and 28:04.070 --> 28:08.920 twenty-eight, which means that it has a low 28:08.918 --> 28:13.418 teaser rate for two years--a teaser, 28:13.420 --> 28:18.970 hat they call it--and then rates that go up after two years 28:18.972 --> 28:24.432 and then tied to some other benchmark rate of interest, 28:24.430 --> 28:26.050 like the Treasury bill rate. 28:26.049 --> 28:33.089 The problem is then that these were sold to low-income people, 28:33.092 --> 28:36.882 in many cases, who didn't understand what they 28:36.881 --> 28:40.641 were getting and that after two years the interest rate would 28:40.638 --> 28:43.338 reset up. So we would see resets after 28:43.341 --> 28:47.661 two years to a much higher level and some of these people would 28:47.662 --> 28:50.452 discover that they can't afford them. 28:50.450 --> 28:57.210 We need--and there's a lot of talk in Congress right now--we 28:57.210 --> 29:02.600 need to think about new regulations that protect 29:02.596 --> 29:07.156 individuals, much like the regulations that 29:07.156 --> 29:09.606 the HOLC and the FHA made. 29:09.609 --> 29:13.369 We have to do it again because the mortgage institutions have 29:13.367 --> 29:14.867 deteriorated somewhat. 29:14.869 --> 29:18.879 There's a lot of anger about this--I know that on Thursday 29:18.882 --> 29:21.912 Angelo Mozilo, who's head of Countrywide, 29:21.910 --> 29:24.710 which is one of the biggest mortgage lenders to low income 29:24.713 --> 29:26.783 people and made a lot of subprime loans, 29:26.779 --> 29:30.639 is being called before a House Committee to testify. 29:30.640 --> 29:33.470 I want to try to watch it if possible. 29:33.470 --> 29:37.060 It's going to be interesting, because there's a lot of anger 29:37.055 --> 29:40.085 about what's happened, similar to the anger that we 29:40.093 --> 29:41.373 saw in the 1930s. 29:41.370 --> 29:47.330 HOLC is no longer with us; it was actually set up as a 29:47.332 --> 29:51.362 temporary corporation by the government. 29:51.359 --> 29:59.109 The FHA is still with us and we just had an FHA Modernization 29:59.114 --> 30:02.724 Act; Congress is starting to propel 30:02.720 --> 30:07.630 that forward so it'll be a bigger part of our-– 30:07.628 --> 30:13.288 I wanted to say a little bit about the math of mortgages. 30:13.289 --> 30:18.449 The typical--I'm going to talk about the conventional 30:18.448 --> 30:23.308 thirty-year mortgage, which has been a standard in 30:23.309 --> 30:28.169 the United States ever since the early 1950s. 30:28.170 --> 30:34.220 It's not a standard in most countries, actually. 30:34.220 --> 30:37.560 I think it was partly the New Deal legislation that made it 30:37.556 --> 30:39.566 very strong in the United States. 30:39.569 --> 30:45.459 In Canada, the mortgages tend to be shorter term. 30:45.460 --> 30:48.460 It's something like what we had in the '30s, although they have 30:48.455 --> 30:50.625 other institutions that protect homebuyers, 30:50.630 --> 30:58.140 so they don't see the turmoil that we saw in the 1930s. 30:58.140 --> 31:09.020 A typical home--a conventional thirty-year--this is what most 31:09.015 --> 31:18.255 people get today and that's--except for subprime. 31:18.259 --> 31:22.069 Subprime borrowers seem to be the ones who are being really 31:22.070 --> 31:23.450 hit with new ideas. 31:23.450 --> 31:27.500 But if most people who are good borrowers, who know what they're 31:27.495 --> 31:29.925 doing, want these, they want a conventional 31:29.933 --> 31:32.913 thirty-year mortgage because it will fix a mortgage payment for 31:32.912 --> 31:36.182 the rest of the thirty years and you have nothing to worry about. 31:36.180 --> 31:41.840 If you can afford the mortgage payment, then you're all set. 31:41.839 --> 31:45.009 You just pay it every month and then you just stop paying at the 31:45.012 --> 31:46.122 end of thirty years. 31:46.119 --> 31:51.359 If they quote the rate on the mortgage, call that 31:51.362 --> 31:57.372 r--traditionally, you would be paying monthly. 31:57.369 --> 32:00.939 If you do it in monthly terms your interest rate is 32:00.940 --> 32:04.940 r/12 because there are twelve months in a year. 32:04.940 --> 32:09.880 How do they figure out what the mortgage payment is? 32:09.880 --> 32:24.800 Well, the mortgage balance is equal to the mortgage payment 32:24.802 --> 32:36.382 times--now we just use the annuity formula, 32:36.380 --> 32:40.330 which is the formula that we've learned again--we've seen it 32:40.326 --> 32:47.536 again and again. [1/ (r/12)][1 – 32:47.538 --> 32:54.618 1/(1 + r/12)^(12T)], 32:54.619 --> 33:06.849 where T is the term, in years, of the mortgage. 33:06.850 --> 33:15.170 33:15.170 --> 33:21.550 I should maybe make this the same--have to get my brackets 33:21.554 --> 33:24.514 right. This is just the annuity 33:24.509 --> 33:26.139 formula, remember? 33:26.140 --> 33:31.240 What this equation merely says is that the present value of 33:31.238 --> 33:35.988 your remaining payments is always equal to the mortgage 33:35.985 --> 33:39.035 balance. This is how they actually 33:39.041 --> 33:43.611 compute the payments because you can take, if you want--if 33:43.605 --> 33:48.085 someone is borrowing--let's bring it up to today--they're 33:48.088 --> 33:50.008 borrowing $200,000. 33:50.009 --> 33:53.709 The median price of a home today is just over $200,000 in 33:53.709 --> 33:56.959 the U.S. If it's an 80% mortgage, 33:56.957 --> 34:02.017 you would be borrowing $160,000, so you'd have a 34:02.024 --> 34:06.664 $160,000 here and you know what this is. 34:06.660 --> 34:09.260 Whatever the mortgage rate is quoted, you substitute it into 34:09.262 --> 34:11.822 this formula and you find out what the square bracket thing 34:11.821 --> 34:13.631 is. Then to get the monthly 34:13.632 --> 34:17.422 payment, you take the square bracketed thing and you divide 34:17.421 --> 34:21.211 by the mortgage balance and that's the monthly payment; 34:21.210 --> 34:22.530 that's how it's calculated. 34:22.530 --> 34:27.240 One peculiar property of this--incidentally, 34:27.244 --> 34:33.274 at every point of time this thing holds, this is time to 34:33.274 --> 34:37.834 maturity. This is years to go and so 34:37.831 --> 34:45.421 12T would be the number of months to go before it ends. 34:45.420 --> 34:49.040 At every point of time your mortgage balance is equal to 34:49.036 --> 34:52.846 your mortgage payment times that square bracketed thing, 34:52.849 --> 34:55.339 where T is the amount of time you have left. 34:55.340 --> 34:59.600 Suppose you are moving after five years, you took out a 34:59.597 --> 35:04.167 thirty-year mortgage and you're moving after five years. 35:04.170 --> 35:07.350 When you first bought the house they told you what the mortgage 35:07.345 --> 35:09.545 payment was and they're fixing that forever, 35:09.548 --> 35:10.878 well for thirty years. 35:10.880 --> 35:14.260 When you get--when you sell the house, what do they do? 35:14.260 --> 35:15.960 They go back to this formula. 35:15.960 --> 35:19.010 If you sold it after five years, then there are 35:19.011 --> 35:22.331 twenty-five years left, so 25 x 12 is the number of 35:22.328 --> 35:24.738 months left; they plug that into this 35:24.735 --> 35:26.835 formula. The mortgage payment was 35:26.840 --> 35:31.040 decided when you took out the mortgage, so that never changes; 35:31.039 --> 35:34.409 they than figure out what your mortgage balance is. 35:34.409 --> 35:36.829 Then the deal is that when you sell the house they 35:36.830 --> 35:38.560 subtract--you've got to pay this. 35:38.559 --> 35:41.239 They subtract this from the purchase price of the house and 35:41.239 --> 35:43.779 then you've got the cash to go and buy another house. 35:43.780 --> 35:45.970 That's how it works, okay? 35:45.969 --> 35:49.619 It's very important to understand that the mortgage 35:49.618 --> 35:53.338 balance is recomputed, according to this formula, 35:53.340 --> 35:56.760 every month and they will send you a statement showing how your 35:56.763 --> 35:58.423 mortgage balance is falling. 35:58.420 --> 36:02.810 A peculiar property of this is that the mortgage balance falls 36:02.806 --> 36:06.326 slowly at first and then it gradually picks up; 36:06.329 --> 36:07.899 it's just a property of this formula. 36:07.900 --> 36:11.150 When you first buy a house most of your payment is going to 36:11.153 --> 36:13.383 interest. Your mortgage payment is 36:13.383 --> 36:17.153 constant through time but the fraction of it that goes to 36:17.149 --> 36:20.919 paying off principal versus interest changes through time 36:20.915 --> 36:24.475 and it just changes as dictated by this formula. 36:24.480 --> 36:27.340 That's because, at the end if--suppose you're 36:27.342 --> 36:31.442 one month or two months away from the payoff of the mortgage, 36:31.440 --> 36:34.610 you don't have any balance left, so the interest that 36:34.606 --> 36:38.256 you're paying is--hardly any balance left--is very low and so 36:38.261 --> 36:40.881 you're payment is paying off principal, 36:40.880 --> 36:44.540 mostly. Whereas, at the beginning, 36:44.538 --> 36:48.168 the mortgage balance is dropping only very slowly 36:48.173 --> 36:52.043 because you've got a lot of interest to pay and your 36:52.035 --> 36:54.605 mortgage payment is constant. 36:54.610 --> 37:00.010 So, that's a funny property of conventional mortgages--that the 37:00.011 --> 37:04.981 mortgage balance declines very slowly at first and then it 37:04.976 --> 37:08.806 falls rapidly when it comes to maturity. 37:08.810 --> 37:17.710 37:17.710 --> 37:22.740 I'll just mention--I want to mention a couple other 37:22.739 --> 37:28.169 institutions that are very important in real estate and 37:28.170 --> 37:31.490 those are Fannie and Freddie. 37:31.489 --> 37:37.499 In 1938, as part of the New Deal--I'll just write Fannie Mae 37:37.497 --> 37:42.687 1938--under the Roosevelt Administration in order to 37:42.691 --> 37:47.071 further work on the problem in housing, 37:47.070 --> 37:51.480 which was still troubling them, they created a government 37:51.481 --> 37:56.131 institution called Federal National Mortgage Corporation. 37:56.130 --> 38:00.430 People on Wall Street found that difficult to say--Federal 38:00.433 --> 38:03.983 National Mortgage Corporation--so they nicknamed 38:03.981 --> 38:06.841 it Fannie Mae; it sounds like a woman's name. 38:06.840 --> 38:12.770 The idea was that they would help advance the mortgage market 38:12.765 --> 38:17.795 by buying up mortgages from mortgage originators and 38:17.802 --> 38:22.842 therefore allowing them to make more mortgages. 38:22.840 --> 38:26.880 They would buy mortgages from originators. 38:26.880 --> 38:31.470 What is an originator? 38:31.469 --> 38:35.609 An originator is a company that lends money to households; 38:35.610 --> 38:39.700 they raise money and then they lend it out as mortgages to 38:39.697 --> 38:42.187 households. Then they deal with the 38:42.185 --> 38:46.105 households by having a local office and telling people what 38:46.109 --> 38:49.969 their balance is and calling them up if they're not paying 38:49.965 --> 38:51.855 and that sort of thing. 38:51.860 --> 38:55.750 Well, they were--a servicer is someone who--might make a 38:55.753 --> 38:59.013 distinction between originator and servicer. 38:59.010 --> 39:00.820 The originator is the one makes the loan; 39:00.820 --> 39:04.850 the servicer is someone who manages the paying of the loan. 39:04.849 --> 39:09.379 Congress thought that these people could be given more money 39:09.383 --> 39:13.843 to operate if someone would buy the mortgages from them, 39:13.840 --> 39:17.000 so Fannie Mae started doing that in 1938. 39:17.000 --> 39:23.190 Then the government created a second such institution 39:23.189 --> 39:29.619 called--and they gave it a boy's name--with a nickname, 39:29.617 --> 39:32.947 boy's name--Freddie Mac. 39:32.949 --> 39:38.069 So, the government created competitors and it privatized 39:38.065 --> 39:43.455 them so that both Fannie and Freddie became what are called 39:43.460 --> 39:48.390 GSEs--these are Government Sponsored Enterprises. 39:48.390 --> 39:56.310 39:56.309 --> 39:59.709 Technically, Fannie and Freddie are private 39:59.713 --> 40:02.553 companies--they're traded stocks; 40:02.550 --> 40:04.770 you can buy shares in Fannie and Freddie. 40:04.769 --> 40:08.699 They're not part of the government, but they were 40:08.702 --> 40:13.542 created by the government and they are massive supporters of 40:13.535 --> 40:15.415 the housing market. 40:15.420 --> 40:19.080 The general market assumes--and also the government still 40:19.079 --> 40:21.989 regulates them. It tells how--there's a 40:21.986 --> 40:26.596 conforming loan limit that is a limit on how much Fannie and 40:26.596 --> 40:31.436 Freddie--how big a mortgage they can make to one homeowner. 40:31.440 --> 40:34.810 It was just part of the new President Bush's plan to 40:34.807 --> 40:38.697 increase the conforming loan limits on Fannie and Freddie to 40:38.702 --> 40:41.412 allow them to lend at a higher price. 40:41.409 --> 40:43.889 So, you can see the government is still involved in them. 40:43.889 --> 40:47.169 While they're technically private companies now, 40:47.171 --> 40:50.451 they are still thought to be related to the U.S. 40:50.452 --> 40:53.202 Government. People are willing to lend to 40:53.204 --> 40:56.324 these organizations at low interest rates because they 40:56.320 --> 40:59.260 think there's an implicit government guarantee. 40:59.260 --> 41:02.230 There are critics of Fannie and Freddie who say, 41:02.231 --> 41:05.711 the government guarantee doesn't sound right because why 41:05.709 --> 41:09.059 is the government guaranteeing a private company? 41:09.059 --> 41:10.719 On the other hand, the government says, 41:10.721 --> 41:11.991 it's not guaranteeing them. 41:11.989 --> 41:14.989 But nobody believes the government when they say that 41:14.987 --> 41:17.117 because people say, surely the U.S. 41:17.119 --> 41:19.529 Government is not going to allow Fannie and Freddie to 41:19.531 --> 41:21.141 fail. This is very important 41:21.137 --> 41:23.417 suddenly, now with the housing crisis. 41:23.420 --> 41:26.860 If you just saw the news yesterday, Fannie Mae is 41:26.860 --> 41:30.300 predicting, well, they are predicting that Fannie 41:30.300 --> 41:34.240 Mae is going to make huge losses in their latest earning 41:34.243 --> 41:37.043 statement. It's still--they can make 41:37.044 --> 41:40.224 losses for a long time before they're in trouble, 41:40.220 --> 41:43.000 so presumably there won't be a problem, 41:43.000 --> 41:47.780 but in principle there could be and so that's the kind of issue 41:47.783 --> 41:49.253 that we have now. 41:49.250 --> 41:52.700 I want to talk about the current boom and I have so much 41:52.696 --> 41:53.946 to say about this. 41:53.950 --> 42:26.680 42:26.679 --> 42:32.129 This is the plot that I created for the second edition of my 42:32.131 --> 42:35.551 book, Irrational Exuberance, 42:35.550 --> 42:38.590 that shows the real estate market in the United States 42:38.593 --> 42:42.973 since 1890. What is really significant--I 42:42.965 --> 42:49.335 created this plot just a couple of years, in 2005. 42:49.340 --> 42:53.500 To my surprise, nobody had before created a 42:53.497 --> 42:57.157 hundred-year long home price index, 42:57.159 --> 43:01.179 which seems surprising to me because the long history of home 43:01.178 --> 43:03.588 prices seems like a relevant fact; 43:03.590 --> 43:06.020 we want to know what markets do. 43:06.019 --> 43:08.989 A lot of people have the impression that home prices only 43:08.992 --> 43:11.542 go up and that they're a wonderful investment. 43:11.539 --> 43:15.089 I thought we should try to find out what home prices have done. 43:15.090 --> 43:21.080 I constructed a series of home prices--that's the red line and 43:21.080 --> 43:27.170 the red line is--you can see how it's moved through history. 43:27.170 --> 43:32.060 It has suddenly shot up in the latest years; 43:32.060 --> 43:33.650 this is since the late 1990s. 43:33.650 --> 43:38.320 This behavior recently, I think, confirms that we are 43:38.323 --> 43:43.633 living in a very unusual time in the housing market and it's 43:43.625 --> 43:47.125 going to put a lot of stress on us. 43:47.130 --> 43:51.050 The only other time we've seen a boom like this was right after 43:51.049 --> 43:54.209 World War II and that's shown by this line here; 43:54.210 --> 43:56.790 that wasn't as big. 43:56.789 --> 44:00.379 After World War II, there were two things that, 44:00.379 --> 44:05.139 I think, contributed to the huge housing boom at that time. 44:05.140 --> 44:06.890 One of them was that the U.S. 44:06.889 --> 44:11.959 Government had shut down the construction industry during the 44:11.963 --> 44:17.293 war, so they didn't build any houses for close to five years; 44:17.289 --> 44:19.419 obviously we had a shortage of housing. 44:19.420 --> 44:22.900 The other thing was the soldiers came back from World 44:22.902 --> 44:25.182 War II and they wanted families. 44:25.179 --> 44:29.399 They started something that you may have heard of called The 44:29.401 --> 44:33.621 Baby Boom, so the birth rate shot way up and everyone wanted 44:33.622 --> 44:36.062 a home. One bedroom wasn't good enough 44:36.061 --> 44:39.421 anymore, they wanted--you don't want the baby in the same room 44:39.419 --> 44:41.919 with you; you want to have two bedrooms. 44:41.920 --> 44:46.180 You might even want two bathrooms, so the demand for 44:46.184 --> 44:50.804 housing went up. The current boom is different 44:50.802 --> 44:56.602 because there's nothing like that happening and so it's 44:56.599 --> 44:58.659 strange. The question is: 44:58.663 --> 45:00.323 what caused the current boom? 45:00.320 --> 45:02.580 I have some other data shown here. 45:02.579 --> 45:08.419 The green line is the building costs and you can see that 45:08.423 --> 45:11.453 building costs, since 1890, 45:11.449 --> 45:15.039 in real terms--everything is corrected for inflation--have 45:15.039 --> 45:18.559 gone up a little bit since 1890, but not a whole lot. 45:18.559 --> 45:22.299 In fact, for the last--this is the Engineering News Record 45:22.297 --> 45:26.197 Building Cost Index; it's an index used by people in 45:26.203 --> 45:28.353 the construction industry. 45:28.349 --> 45:30.269 Since around 1980, building costs have been 45:30.272 --> 45:31.662 falling. That, I think, 45:31.658 --> 45:35.438 is partly because the biggest single component of building 45:35.436 --> 45:37.656 costs is labor. As you know, 45:37.659 --> 45:42.719 income inequality is getting worse, low-income wages are not 45:42.718 --> 45:47.778 going up, so that component of housing has been declining in 45:47.777 --> 45:51.167 real terms. The other components are not 45:51.172 --> 45:54.652 doing much. The other thing I have down is 45:54.651 --> 45:58.831 population, although the population of the U.S. 45:58.829 --> 46:01.869 has been pretty steady--that pink line looks awfully 46:01.872 --> 46:04.022 steady--and I have interest rates. 46:04.019 --> 46:05.929 Now a lot of people talk about interest rates. 46:05.929 --> 46:08.169 I was just reading Alan Greenspan's new book, 46:08.171 --> 46:09.751 The Age of Turbulence. 46:09.750 --> 46:11.930 I don't know if you saw this; it came out last year. 46:11.929 --> 46:14.959 He said, he didn't think there was a bubble. 46:14.960 --> 46:18.020 I don't know how he could not think there was a bubble, 46:18.024 --> 46:19.334 but he didn't see it. 46:19.329 --> 46:23.119 His honest--he said, maybe froth in the real estate 46:23.119 --> 46:25.089 market but not a bubble. 46:25.090 --> 46:29.310 Anyway, I was reading--well, why didn't he think there was a 46:29.306 --> 46:30.676 bubble? He said, well part of the 46:30.681 --> 46:31.941 reason is interest rates were coming down. 46:31.940 --> 46:35.330 If interest rates are coming down, as you can see they are, 46:35.329 --> 46:38.779 that means the rate of discount is going down in the present 46:38.777 --> 46:41.147 value formula, so asset pricing should go up. 46:41.150 --> 46:44.280 I guess that's plausible. 46:44.280 --> 46:47.640 It doesn't match up very well though because interest rates 46:47.639 --> 46:51.229 have been going down since 1980 and the boom is very sudden, 46:51.230 --> 46:54.130 so it seems to me that Greenspan should have seen this 46:54.133 --> 46:57.933 bubble coming. What caused--that's the--I 46:57.929 --> 47:04.669 wanted to show you one city--I actually do a short comparison 47:04.668 --> 47:11.068 between a couple of cities--Los Angeles and Milwaukee. 47:11.070 --> 47:13.270 Is there anyone here from Los Angeles? 47:13.270 --> 47:15.110 We've got a good number. 47:15.110 --> 47:16.520 What about Milwaukee? 47:16.519 --> 47:22.259 Nobody from Milwaukee--I might be insulting Milwaukeeans when I 47:22.261 --> 47:25.041 talk about this--not really. 47:25.039 --> 47:29.079 Milwaukee--is there someone up there? 47:29.080 --> 47:33.640 No. Milwaukeeans are much more 47:33.641 --> 47:42.111 stable than--this is actually praise for Los--for Milwaukeeans 47:42.113 --> 47:50.033 not--Milwaukeeans are much more stable than Angelinos, 47:50.030 --> 47:51.300 I guess you call them, right? 47:51.300 --> 47:52.720 Los Angeles residents? 47:52.719 --> 47:56.659 Look what the housing--the blue line shows what home prices in 47:56.660 --> 48:00.210 real terms have done in Los Angeles over the last thirty 48:00.213 --> 48:02.563 years. We compare Milwaukee--look at 48:02.563 --> 48:04.093 that, isn't that amazing? 48:04.090 --> 48:08.320 Milwaukee has been extremely steady over this period. 48:08.320 --> 48:10.980 One theory is that, well it's, as people say, 48:10.977 --> 48:12.907 I'm going back to Los Angeles. 48:12.909 --> 48:16.379 The problem with Los Angeles is that they've had unsteady 48:16.380 --> 48:18.240 employment and unemployment. 48:18.239 --> 48:23.239 If the economy is sagging, then the Los Angeles housing 48:23.235 --> 48:25.265 prices will respond. 48:25.269 --> 48:28.949 Well, you can see the pink line shows the employment in Los 48:28.945 --> 48:31.545 Angeles, and indeed, it did move around 48:31.547 --> 48:35.637 corresponding to the booms and busts in the Los Angeles market 48:35.638 --> 48:37.448 but not so dramatically. 48:37.449 --> 48:41.259 If you look at Milwaukee, the employment figures don't 48:41.263 --> 48:44.433 look that much different than Los Angeles. 48:44.430 --> 48:46.570 What's different? 48:46.570 --> 48:49.880 There's something about Los Angeles that's different from 48:49.875 --> 48:53.115 Milwaukee and that is that in Los Angeles there's just a 48:53.121 --> 48:55.011 history of volatile markets. 48:55.010 --> 49:00.050 I wanted to try and figure out why. 49:00.050 --> 49:04.230 The reason we picked these two cities--we asked realtors--Karl 49:04.234 --> 49:07.534 Case, who's my colleague, he teaches at Wellesley 49:07.526 --> 49:09.126 College. Back in 1988, 49:09.133 --> 49:12.453 when we started this study, we asked realtors around the 49:12.445 --> 49:16.055 country, what is the hottest market in the United States? 49:16.059 --> 49:19.949 They said, oh that's Los Angeles or maybe Anaheim, 49:19.953 --> 49:21.943 which is right outside. 49:21.940 --> 49:25.080 Then we said, what's the deadest market in 49:25.078 --> 49:26.608 the United States? 49:26.610 --> 49:29.390 There wasn't as much agreement on that, but one of the names 49:29.393 --> 49:32.203 suggested was Milwaukee; nothing has ever happened there 49:32.203 --> 49:33.483 in terms of real estate. 49:33.480 --> 49:37.820 Now, I think that ultimately--interestingly 49:37.818 --> 49:43.708 enough, Los Angeles had a real estate boom and bust in the 49:43.706 --> 49:46.436 1880s; that's hard to believe. 49:46.440 --> 49:49.570 There was a huge boom in real estate prices in L.A. 49:49.570 --> 49:53.160 in--it peaked in 1886 and then it crashed. 49:53.159 --> 49:57.929 Now, you might think that's a long time ago, 49:57.932 --> 50:00.742 1886? Isn't that when the cowboys and 50:00.743 --> 50:04.813 Indians were out there in the Old West in the covered wagons? 50:04.809 --> 50:08.689 Well that's right, but there was a real estate 50:08.685 --> 50:10.575 boom in Los Angeles. 50:10.579 --> 50:14.299 I went back and studied this boom rather extensively 50:14.295 --> 50:17.205 by--there's one book written about it. 50:17.210 --> 50:18.470 There's also The L.A. 50:18.469 --> 50:21.399 Times, which you can get now online with no problem from 50:21.402 --> 50:23.492 the--you can read every day's newspaper. 50:23.489 --> 50:28.289 It turns out--I was talking about what happened in L.A. 50:28.289 --> 50:34.199 in the 1880s--a view arose that Los Angeles was just the most 50:34.200 --> 50:36.860 wonderful place on Earth. 50:36.860 --> 50:39.390 The climate out there is beautiful, especially if you 50:39.387 --> 50:41.377 feel that on a winter's day like today, 50:41.380 --> 50:44.460 you might wish you were in--some of you might wish you 50:44.463 --> 50:47.223 were there. It wasn't just California, 50:47.219 --> 50:51.679 because California was a huge state, with all kinds of--but 50:51.678 --> 50:53.368 mostly empty--land. 50:53.369 --> 50:57.419 People somehow got the idea that Los Angeles is just this 50:57.417 --> 51:01.457 wonderful city and so they started bidding up real estate 51:01.464 --> 51:03.624 prices. You can explain that to me, 51:03.624 --> 51:05.144 some of you from Los Angeles. 51:05.139 --> 51:09.379 It turned out to be kind of wrong because in the 1880s they 51:09.375 --> 51:13.825 started building so many houses in response to the demand that 51:13.830 --> 51:18.310 there was eventually a crash; but somehow people got this 51:18.306 --> 51:19.756 idea at some time. 51:19.760 --> 51:23.450 We compared Los--we couldn't go back in a time machine and do 51:23.447 --> 51:27.137 questionnaire surveys in the 1880s, but we could do it in the 51:27.135 --> 51:29.865 1980s. So, Case and I did identical 51:29.873 --> 51:34.123 questionnaires in Los Angeles and Milwaukee and these are 51:34.120 --> 51:36.320 median price expectations. 51:36.320 --> 51:39.590 In 1988, when there was a boom in California, 51:39.588 --> 51:43.908 but of course not in Milwaukee, the average person in Los 51:43.909 --> 51:48.169 Angeles thought home prices would go up 10% a year for the 51:48.172 --> 51:50.942 next ten years--that's the median, 51:50.940 --> 51:54.340 I'm sorry. 10% a year is a pretty fast 51:54.343 --> 51:57.243 appreciation. If it goes on for ten years 51:57.243 --> 52:00.433 that means that the--it'll double in seven years, 52:00.431 --> 52:03.621 so it'd be going up like two and a half fold. 52:03.619 --> 52:07.659 That was quite a nice expectation. 52:07.659 --> 52:10.029 If you compare that with Milwaukee, they thought only 4%, 52:10.033 --> 52:11.563 which is about the inflation rate. 52:11.559 --> 52:14.759 So, there was something different between Los Angeles 52:14.764 --> 52:17.624 and Milwaukee. The Los Angeles people had 52:17.618 --> 52:19.988 extravagantly high expectations. 52:19.989 --> 52:24.539 We saw it again in 2003, when people in Los Angeles 52:24.535 --> 52:27.985 expected 8% appreciation every year. 52:27.990 --> 52:33.620 It's coming down now in 2006; they're gradually coming down 52:33.617 --> 52:35.047 as the boom unwinds. 52:35.050 --> 52:37.130 You notice Milwaukee is going up. 52:37.130 --> 52:40.430 I think what's happening is that we're becoming more 52:40.431 --> 52:44.061 national and Milwaukeeans are starting to think more like 52:44.057 --> 52:47.677 Angelinos--that it's one boom--so they start to expect it 52:47.682 --> 52:49.562 to happen in Milwaukee. 52:49.559 --> 52:53.249 Los Angeles and Milwaukee were tied in 2006 for their 52:53.246 --> 52:56.046 expectations. This is the boom. 52:56.050 --> 53:00.820 People had great fear of being left out of the real estate 53:00.817 --> 53:03.197 market. I think the boom was driven by 53:03.195 --> 53:05.505 fear. In 1988, we asked people in Los 53:05.511 --> 53:09.431 Angeles, are you worried that unless I buy now I won't be able 53:09.431 --> 53:11.681 to afford a house in the future? 53:11.679 --> 53:15.719 We had 80% agreement with that in Los Angeles; 53:15.720 --> 53:17.260 so people were really worried. 53:17.260 --> 53:20.940 In Milwaukee, it was only 27%. 53:20.940 --> 53:23.750 You kind of wonder, how can it be that people had 53:23.749 --> 53:27.319 such different views depending on which city they lived in? 53:27.320 --> 53:30.710 Well, I can kind of explain it; there are a couple of factors. 53:30.710 --> 53:34.650 One is, in 1988 home prices were rising rapidly in Los 53:34.654 --> 53:38.234 Angeles, not so in Milwaukee, so people were just 53:38.226 --> 53:40.976 extrapolating the price increase. 53:40.980 --> 53:45.400 The other thing is that Los Angeles just has this sense of 53:45.400 --> 53:50.210 its own glamour and excitement that--you know it is the home of 53:50.209 --> 53:54.009 movie stars. What city is more glamorous? 53:54.010 --> 53:56.690 Beverly Hills is part of Los Angeles; 53:56.690 --> 53:59.760 it's the most expensive city in the U.S. 53:59.760 --> 54:04.370 This sense, this glamour thinking, along with price 54:04.371 --> 54:08.061 increases, caused Los Angeles to boom; 54:08.060 --> 54:10.860 so it's the boomiest U.S. city. 54:10.860 --> 54:16.000 We asked people whether they had a perception of excitement 54:16.000 --> 54:20.610 directly and in Los Angeles, in 1988,54% said yes; 54:20.610 --> 54:23.800 whereas, in Milwaukee only 21% said yes. 54:23.800 --> 54:27.180 As the years go by, you notice that Milwaukee is 54:27.184 --> 54:30.574 starting look more and more like Los Angeles. 54:30.570 --> 54:32.560 Alan Greenspan, in his book, 54:32.559 --> 54:36.829 says that he thinks housing markets are all local and there 54:36.834 --> 54:41.184 is no--he says this firmly in his book--there is no national 54:41.182 --> 54:44.712 housing market. In fact, it's becoming more 54:44.708 --> 54:49.328 national because Milwaukeeans no longer think that they are some 54:49.326 --> 54:53.866 kind of outpost that's unrelated to the excitement of glamorous 54:53.870 --> 54:56.640 cities; they see it happening at home 54:56.635 --> 54:59.165 as well. Now, I wanted to compare it 54:59.167 --> 55:03.277 with another question that I--people have this simple idea 55:03.277 --> 55:05.727 that there's a best investment. 55:05.730 --> 55:09.650 This is about the stock market, but I asked a number of--this 55:09.652 --> 55:13.442 I've been doing since 1996--do you agree with the following 55:13.444 --> 55:16.164 statement? "The stock market is the best 55:16.158 --> 55:19.688 investment for long-term holders who can just buy and hold 55:19.693 --> 55:22.363 through the ups and down of the market." 55:22.360 --> 55:26.200 I only started asking this in 1996 when the stock market boom 55:26.197 --> 55:29.437 was well under way, but already 69% of my 55:29.440 --> 55:33.330 respondents, who were high-income investors, 55:33.330 --> 55:37.500 strongly agreed. That percent grew to the peak 55:37.503 --> 55:41.643 of the market in 1999; after the peak in 2000 it began 55:41.635 --> 55:43.855 to fall. We see what happens is that 55:43.862 --> 55:46.872 when the markets--people are chasing past returns. 55:46.869 --> 55:49.859 When the stock market is going up they think that--they 55:49.855 --> 55:52.945 increasingly think that the stock market is just the best 55:52.950 --> 55:55.450 investment, until when it starts falling, 55:55.450 --> 55:57.640 then they start retracting from that. 55:57.639 --> 56:05.519 I didn't have--I lost it--what is going on here? 56:05.520 --> 56:15.100 56:15.099 --> 56:18.029 We see the same thing in real estate. 56:18.030 --> 56:22.300 The percent who think it's the best investment is higher in Los 56:22.301 --> 56:26.081 Angeles than in Milwaukee, and since the peak of the 56:26.084 --> 56:29.134 bubble in 2003, it's been declining in Los 56:29.127 --> 56:30.977 Angeles but, surprisingly, 56:30.981 --> 56:32.181 rising in Milwaukee. 56:32.179 --> 56:37.199 They've almost--they've pretty much converged in 2006. 56:37.199 --> 56:39.739 The lesson is, I think, that we have a 56:39.743 --> 56:43.663 glamour-city phenomenon--that excitement about real estate 56:43.660 --> 56:46.960 prices--centered in places like Los Angeles, 56:46.960 --> 56:49.770 but it's spreading and becoming more and more of a national 56:49.772 --> 56:51.472 phenomenon and that's the bubble. 56:51.469 --> 56:56.879 Part of--this is the--it's not loan-to-value ratio--this is the 56:56.878 --> 57:00.798 ratio of mortgage debt to personal consumption 57:00.804 --> 57:03.964 expenditure. Over the boom period, 57:03.963 --> 57:07.073 we've been seeing a gradual uptrend; 57:07.070 --> 57:12.340 just as loan to value ratios were only 60% in the 1920s, 57:12.336 --> 57:15.396 now they're up to 90% or 100%. 57:15.400 --> 57:19.130 We're much more willing to take risks on mortgages. 57:19.130 --> 57:21.350 People are also borrowing much more. 57:21.349 --> 57:25.999 You can see that in the early 1950s mortgage debt was only 57:26.004 --> 57:30.414 something like 25% of personal consumption expenditure, 57:30.413 --> 57:33.193 but now it's up to about 100%. 57:33.190 --> 57:37.150 We're much more expansive in mortgage financing than we were. 57:37.150 --> 57:41.500 I put this chart out to just show the international aspect of 57:41.504 --> 57:44.344 home prices. Here, the blue line is the 57:44.343 --> 57:47.853 Case-Shiller Home Price Index for greater Boston. 57:47.849 --> 57:52.709 The red line is the Halifax Home Price Index for greater 57:52.710 --> 57:55.450 London--we're talking UK now. 57:55.449 --> 57:59.019 They're both deflated by the Consumer Price Index or, 57:59.021 --> 58:02.591 in the case of the UK, the Retail Price Index to give 58:02.592 --> 58:04.312 us a real home price. 58:04.309 --> 58:07.969 Isn't it striking how similar London and Boston are? 58:07.970 --> 58:10.180 They both had dramatic booms. 58:10.179 --> 58:14.729 The London boom of the late 1980s is really something--look 58:14.726 --> 58:17.066 at that. It went up, peaked, 58:17.069 --> 58:21.009 suddenly turned around, came all the back down. 58:21.010 --> 58:26.040 I don't know what to--and then it kind of waffled around in 58:26.036 --> 58:29.586 London and then it shot up even higher. 58:29.590 --> 58:32.070 Then, look what's happened--this is the latest 58:32.070 --> 58:34.330 quarter--it's starting to fall rapidly. 58:34.329 --> 58:38.009 Just a couple of months ago London seemed to be soaring and 58:38.008 --> 58:41.498 now suddenly there's this pessimistic atmosphere because 58:41.495 --> 58:44.725 we don't know what's going to happen in London. 58:44.730 --> 58:50.240 Look how it fell in 2004; there was this sharp drop and 58:50.242 --> 58:55.512 most people thought that the housing boom was over but then 58:55.507 --> 58:59.317 it went up again to a new peak in 2007. 58:59.320 --> 59:02.900 We have an international crisis. 59:02.900 --> 59:04.410 This is another couple of countries. 59:04.409 --> 59:08.839 I managed to find price indexes for Norway and Netherlands going 59:08.843 --> 59:12.083 back to 1890 and compared that with the U.S. 59:12.079 --> 59:15.069 We're seeing a similar pattern in all three of these countries. 59:15.070 --> 59:18.510 These are the only countries that I've been able to find that 59:18.505 --> 59:21.015 have high-quality, repeat sales price indexes 59:21.024 --> 59:22.804 going back a hundred years. 59:22.800 --> 59:26.420 You can see that in all these countries real estate prices 59:26.419 --> 59:30.099 didn't show much trend until recently and now they all have 59:30.102 --> 59:31.502 real estate booms. 59:31.500 --> 59:33.550 We have an international boom. 59:33.550 --> 59:35.890 Why is that? Why would we have an 59:35.894 --> 59:36.744 international boom? 59:36.739 --> 59:40.539 I talk about this in the book you have, Irrational 59:40.540 --> 59:43.830 Exuberance, and I'll let you read that and 59:43.829 --> 59:45.729 not summarize it here. 59:45.730 --> 59:49.550 But, part of the reason I think is, globalization is creating a 59:49.549 --> 59:52.749 global culture and the excitement and enthusiasm that 59:52.753 --> 59:56.133 we once saw in isolated cities, like Los Angeles, 59:56.125 --> 1:00:00.625 are spreading out and are seen more and more around the world. 1:00:00.630 --> 1:00:03.760 It's tied in with our sense of rapid economic growth. 1:00:03.760 --> 1:00:08.750 We're living in an era of excited economic optimism and 1:00:08.752 --> 1:00:12.822 it's feeding into home prices in the U.S., 1:00:12.820 --> 1:00:16.090 in Europe, in China, in Korea, in India, 1:00:16.094 --> 1:00:19.794 in South Africa, Australia, New Zealand--lots 1:00:19.787 --> 1:00:24.827 and lots of places have seen home price boom and I think it's 1:00:24.825 --> 1:00:30.025 not anything unique to any one country that explains it; 1:00:30.030 --> 1:00:31.630 it's the psychology. 1:00:31.630 --> 1:00:38.280 This is residential investment in the United States as a 1:00:38.275 --> 1:00:43.485 fraction of GDP. I have it shown with the--the 1:00:43.491 --> 1:00:49.371 vertical lines on this chart indicate recessions and this 1:00:49.365 --> 1:00:55.865 shows--this is from 1948 to 2007 and every recession that we've 1:00:55.868 --> 1:00:58.908 had since 1948 is shown. 1:00:58.909 --> 1:01:03.609 For example, we had a recession that started 1:01:03.605 --> 1:01:09.825 here--I believe that was '48--and then it ended in '49. 1:01:09.829 --> 1:01:15.289 Then we had another recession that began in 1953--that's that 1:01:15.290 --> 1:01:18.840 line--and it ended in '54, and so on. 1:01:18.840 --> 1:01:22.770 The most recent recession we've had is 2001; 1:01:22.769 --> 1:01:25.629 it began and ended in the same year, 2001. 1:01:25.630 --> 1:01:30.590 We may be in a recession now; a lot of people are saying 1:01:30.590 --> 1:01:35.060 that, so I would be tempted to draw a new line here, 1:01:35.062 --> 1:01:39.362 somewhere around here, maybe December of 2007. 1:01:39.360 --> 1:01:43.220 The National Bureau of Economic Research, who announces 1:01:43.219 --> 1:01:46.359 recession dates, hasn't announced yet whether 1:01:46.364 --> 1:01:49.674 there's a recession, so we'll probably find out in a 1:01:49.666 --> 1:01:52.426 few more months whether we're already in a recession. 1:01:52.430 --> 1:01:53.630 I suspect we are. 1:01:53.630 --> 1:01:58.890 Now the interesting thing is, the green line here is the 1:01:58.886 --> 1:02:02.706 expenditure on real estate investment. 1:02:02.710 --> 1:02:03.470 What does that mean? 1:02:03.470 --> 1:02:04.950 There are three main components. 1:02:04.949 --> 1:02:08.509 One is building new houses, another one is building new 1:02:08.505 --> 1:02:12.315 apartment buildings--that's commercial instead of--but it's 1:02:12.323 --> 1:02:15.883 still adding to the housing stock--and the third one is 1:02:15.878 --> 1:02:18.378 improvements of existing houses. 1:02:18.380 --> 1:02:21.550 People put new additions on or they redo the kitchen and 1:02:21.547 --> 1:02:22.927 bathroom and whatever. 1:02:22.929 --> 1:02:27.029 So, we add all of that up and that's residential investment. 1:02:27.030 --> 1:02:31.160 You can see that residential investment, as a fraction of 1:02:31.159 --> 1:02:35.289 GDP, has been very variable through history of the United 1:02:35.288 --> 1:02:39.048 States since World War II and that it's had a strong 1:02:39.049 --> 1:02:41.629 relationship with recessions. 1:02:41.630 --> 1:02:48.450 You can see what residential investment has done recently. 1:02:48.449 --> 1:02:54.929 We had a huge peak in residential investment and the 1:02:54.926 --> 1:03:01.016 peak was a couple of years ago--I believe 2006 or 1:03:01.021 --> 1:03:08.391 thereabouts--at the level of residential investment was the 1:03:08.386 --> 1:03:15.366 highest it has been since 1951--that's over here. 1:03:15.369 --> 1:03:18.449 That's the only time since World War II that we've had a 1:03:18.446 --> 1:03:20.736 higher level of residential investment. 1:03:20.739 --> 1:03:26.849 Even 1951 was a very unusual year--I'll tell you why--because 1:03:26.850 --> 1:03:30.720 we were getting into the Korean War. 1:03:30.719 --> 1:03:37.469 People remembered that during World War II the U.S. 1:03:37.469 --> 1:03:39.389 Government shut down the housing market. 1:03:39.389 --> 1:03:42.619 They said, no more new houses to be built, so everyone 1:03:42.621 --> 1:03:45.911 thought--in fact they were talking about World War III, 1:03:45.913 --> 1:03:47.623 they were really scared. 1:03:47.619 --> 1:03:50.589 You don't remember how awful it looked because the U.S. 1:03:50.590 --> 1:03:54.880 was proposing to invade Korea and then the Soviet Union and 1:03:54.879 --> 1:03:59.389 China were being very angry and we thought we'd be in some war 1:03:59.390 --> 1:04:02.570 with Communist China or some awful war. 1:04:02.570 --> 1:04:05.760 People got really scared, but what they did was 1:04:05.760 --> 1:04:07.910 they--this was the Baby Boom. 1:04:07.909 --> 1:04:10.919 They just got back from World War II, they didn't want another 1:04:10.918 --> 1:04:12.938 war, they wanted to live a normal life, 1:04:12.940 --> 1:04:16.160 they wanted to have kids, and then this terrible war was 1:04:16.162 --> 1:04:17.512 coming, they thought. 1:04:17.510 --> 1:04:20.360 So, they rushed and bought houses. 1:04:20.360 --> 1:04:24.060 Everyone was scrambling to get a house before they shut down 1:04:24.062 --> 1:04:25.382 the housing market. 1:04:25.380 --> 1:04:28.570 It turns out that it didn't turn into World War III 1:04:28.574 --> 1:04:32.344 and--maybe they did shut down the housing--or they must have 1:04:32.343 --> 1:04:35.743 curtailed it, but it created that boom. 1:04:35.740 --> 1:04:37.640 What's causing this boom here? 1:04:37.639 --> 1:04:40.409 It's almost as big as the 1951 boom. 1:04:40.409 --> 1:04:44.679 Well, the answer is high prices, I believe. 1:04:44.679 --> 1:04:49.039 We had this huge bubble in home prices and it pushed prices up 1:04:49.041 --> 1:04:50.901 to extraordinary levels. 1:04:50.900 --> 1:04:52.820 What does that do to builders? 1:04:52.820 --> 1:04:55.740 Well, builders can sell for a really high price, 1:04:55.736 --> 1:04:58.276 so they start building a lot of houses. 1:04:58.280 --> 1:05:01.910 They will do it as long as the home price is high relative to 1:05:01.914 --> 1:05:03.554 their construction costs. 1:05:03.550 --> 1:05:08.640 We've seen a boom in building in the United States that is at 1:05:08.638 --> 1:05:12.828 a record level, except for that one Korean War 1:05:12.831 --> 1:05:18.061 blip, and so I think it's a highly abnormal situation that 1:05:18.060 --> 1:05:22.180 we've been in. Now, look how suddenly and 1:05:22.181 --> 1:05:25.531 sharply it's correcting downward. 1:05:25.530 --> 1:05:27.300 Why is it correcting downward? 1:05:27.300 --> 1:05:30.040 Well, that's because the housing market is now in 1:05:30.039 --> 1:05:32.599 decline. When the housing market is in 1:05:32.595 --> 1:05:36.425 decline, the ability to sell houses drops dramatically. 1:05:36.429 --> 1:05:40.539 Builders were doing extremely well until a couple of years 1:05:40.541 --> 1:05:44.001 ago--their stock was soaring--now all of a sudden 1:05:44.003 --> 1:05:45.593 they're in crisis. 1:05:45.590 --> 1:05:49.590 Well, it's no surprise; this is what a housing bubble 1:05:49.590 --> 1:05:52.270 does. You can see various--this is 1:05:52.273 --> 1:05:56.843 the growth rate of home prices--actually I should update 1:05:56.836 --> 1:05:58.986 this. This is now tipped negative. 1:05:58.989 --> 1:06:03.859 The peak--this is the Case-Shiller ten-city index. 1:06:03.860 --> 1:06:06.780 Housing permits have dropped way off because, 1:06:06.782 --> 1:06:09.972 of course, they're not building homes anymore. 1:06:09.969 --> 1:06:15.059 This shows a strong seasonality and then a drop off since 2006. 1:06:15.059 --> 1:06:18.799 Here's my last slide--The National Association of 1:06:18.801 --> 1:06:23.011 Homebuilders surveys its membership to ask them what is 1:06:23.011 --> 1:06:25.351 the traffic of homebuyers? 1:06:25.349 --> 1:06:28.779 What they mean by that is, if you're a builder and you 1:06:28.777 --> 1:06:32.267 have this place where you show off your model homes, 1:06:32.269 --> 1:06:36.029 how many people are coming by to look at your model homes 1:06:36.030 --> 1:06:37.910 today as potential buyers? 1:06:37.909 --> 1:06:41.579 The blue line is the traffic of homebuyers. 1:06:41.579 --> 1:06:44.969 You can see that it has reached the lowest level ever. 1:06:44.969 --> 1:06:48.629 It has dropped precipitously and you note that the pink line, 1:06:48.631 --> 1:06:51.561 which shows the rate of growth of home prices, 1:06:51.559 --> 1:06:54.399 the rate of growth of home prices, has fallen just right 1:06:54.397 --> 1:06:56.407 along with the traffic of homebuyers. 1:06:56.409 --> 1:06:58.729 I think it's pretty clear what's happening. 1:06:58.730 --> 1:07:01.430 People saw the rising home prices; 1:07:01.429 --> 1:07:03.209 they thought they would rise forever; 1:07:03.210 --> 1:07:06.750 they were flocking in, trying to get into the housing 1:07:06.747 --> 1:07:09.057 market before it outpriced them. 1:07:09.059 --> 1:07:11.299 Now suddenly, the word is that it's falling, 1:07:11.298 --> 1:07:14.368 so suddenly they don't want these homes, so the inventory of 1:07:14.370 --> 1:07:18.190 unsold homes has shot up; builders can't sell them and 1:07:18.190 --> 1:07:19.840 prices are falling. 1:07:19.840 --> 1:07:21.540 That's the situation we're in. 1:07:21.539 --> 1:07:25.419 We'll talk more about this very interesting situation because it 1:07:25.424 --> 1:07:29.004 ties in with so many other aspects of financial markets.