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Fri November 15, 2013
What's A Bubble?
Originally published on Sun November 17, 2013 1:58 pm
Robert Shiller was surprised when he got the call telling him he'd won the Nobel Memorial Prize in economics — surprised that he'd won (of course), but also surprised that he was sharing the award with Eugene Fama.
"He and I seem to have very different views," Shiller told me. "It's like we're different religions."
In particular, they have very different views about economic bubbles.
"The word 'bubble' drives me nuts, frankly," Fama told me.
Fama believes markets are basically rational. At any given moment, he says, prices reflect the collective wisdom of everyone in the market. If it were clear that prices were irrationally inflated, investors would stop buying en masse — and prevent a bubble from getting out of control, he says.
Shiller, on the other hand, is famous for describing bubbles, and for predicting the two big ones of our time — the dot-com bubble and the housing bubble.
Fama is unimpressed. "What happens each time is the media goes in and finds somebody who predicted it, and that person gets anointed," he says. "You don't go back and look at past predictions and see, 'Is this just luck?' "
Fama says if Shiller could predict, say, the next 10 bubbles, he would be convinced. Shiller says he thinks he probably could predict the next 10 — if he lived long enough.
This is more than an academic debate. If you believe bubbles are predictable then maybe you can slow or stop them. If you think they're hard or impossible to spot, there's not much to be done.
RENEE MONTAGNE, HOST:
The latest Nobel Laureates will get dressed up next month to accept their prizes in Stockholm. And on stage for the economics prize will be an unlikely pair - two economists who disagree about one of the biggest questions out there. Which is can anything be done to prevent economic bubbles? David Kestenbaum with our Planet Money team tracked down both of those laureates to talk over their differences.
DAVID KESTENBAUM, BYLINE: When Robert Shiller at Yale University got the call that he'd won the Nobel Prize, he was surprised. Surprised to win, but also surprised when the folks on the phone told him who he was sharing the Nobel Prize with: Eugene Fama, an economist at the University of Chicago.
ROBERT SHILLER: That was a complete surprise. He and I seem to have very different views. It's like we are different religions, you know?
KESTENBAUM: How different? Take that term bubble. People use it all the time. There was a famous Dutch tulip bubble in the 1600s.
More recently of course the dot com bubble and our housing bubble where prices came crashing down. You know, bubbles.
GENE FAMA: The word bubble drives me nuts, frankly.
KESTENBAUM: That is Shiller's co-laurate, Eugene Fama. Fama believes markets are basically rational. Sure prices go up, sometimes they come back down. That's normal, he says. Prices reflect the collective wisdom of everyone in the market. So, Fama says what exactly does Robert Shiller mean by a bubble? What is his definition? I asked Shiller.
SHILLER: I give a kind of long-winded definition. It's like a - see, it's like a mental illness. If you look at the American Psychiatric Association's diagnostic and statistical manual which defines mental illnesses, the mental illness definitions consist of a checklist of symptoms.
KESTENBAUM: Here is part of the Shiller checklist applied to the last housing boom. Symptom one: rapidly increasing prices. Check, home prices in Miami basically doubled in a few years. Symptom two: People tell each other stories that purport to justify the bubble. Check, I have a book at my desk from this time period. Title 'Why the Real Estate Boom Will not Bust.' Symptom three: People feel envy and regret haven't participated. Check, I did.
SHILLER: There is an impulse to buy into it because of the swirl of emotions that one feels. Oh I would add one more - the news media are involved.
KESTENBAUM: Thanks a lot.
SHILLER: Well, there were no bubbles before there were news media.
KESTENBAUM: Fama's response to this definition is so what. Lots of things that meet that definition don't end up crashing. Look at Google, for instance. Rapid run up in price, check. There are stories people tell to justify the price, check. Those guys at Google are geniuses - lots of emotion, regret, check. Google used to be $85 a share, it's now over $1000 a share. Fama says if you say something is a bubble, you are basically predicting the price will crash spectacularly. And he just doesn't think anyone can do that.
FAMA: Because I don't think there is anything in the statistical evidence that says anybody can reliably predict when prices go down. So if you interpret the word bubble to mean I can predict when prices are going to go down, you can't do it.
KESTENBAUM: I mention that Robert Shiller is often credited in the press with predicting two bubbles - the stock market crash in the 1980s and the recent housing mess. Fama shrugs.
FAMA: So what happens each time is the media goes in and finds somebody who predicted it and that person gets anointed. You don't go back and look at past predictions and see is this just luck.
KESTENBAUM: So what is your challenge to Robert Shiller? He should predict the next bubble?
FAMA: Right. Not just the next one. You know, statistical reliability means more than two, really.
KESTENBAUM: The next 10?
FAMA: Well, the next 10 would be really convincing. Yeah. Then I'd be convinced.
KESTENBAUM: I put the challenge to Robert Shiller. Could you predict the next ten?
SHILLER: If I lived long enough, yeah.
KESTENBAUM: You do think you could?
SHILLER: I think so. But - yeah. I'm not the most self-confident person.
KESTENBAUM: This is more than an academic debate. If you believe bubbles are predictable then maybe you can slow or stop them. But if you think they're hard or impossible to spot, there's not much to be done. The Nobel committee noted the surprising and contradictory nature of this year's prize, which is perhaps why Shiller and Fama will be accepting their medals next month with a third man. There's a third laureate - Lars Peter Hansen from the University of Chicago. Hansen developed the statistical math for how to resolve debates like this. So maybe there's hope. David Kestenbaum, NPR News.
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