by Calculated Risk on 2/17/2006 08:59:00 PM

The Financial Times' Jim Pickard has lunch with Dr. Robert Shiller: The man and the bubble. A few excerpts:

What I really want to know, not least as a homeowner, is when and how the property market will crash. So I ask him.

For a man whose written predictions seem so definite - and dire - he appears loath to be nailed as an inveterate doomster. "I really don’t know what prices will do," he says hesitantly, playing with his cutlery.

But hasn’t he predicted a huge drop in US house prices? Only in some specific cities and states, he clarifies.

The professor is no doubt aware that the history of economic forecasting is littered with the names of those who made the right forecasts at the wrong time.

And more:

What, exactly, can Ben Bernanke, Greenspan’s successor, do to rescue the US economy if the property market crashes? Has the Fed already used up its one silver bullet - that of interest rate cuts?

"Bernanke thinks there is no housing bubble," says Shiller. "According to the White House website, he said recently that the fundamentals explained house price movements except in some speculative markets." The new chairman of the Fed is a "brilliant man", Shiller continues, but he has not shown any interest in behavioural economics.

And this is where he has underestimated the danger posed by real estate speculation. "He is not attuned to one of the great innovations of our time, that is, bringing psychology back into economics."

Here we come to the crux of Shiller’s theories about asset bubbles, whether tulips, shares or property: people get excited as they see the price of an asset rising, so they buy more, which pushes the prices up further until they are unsustainable. "The bubble is made by a ‘story’, by excitement and glamour," he says. And then, once a market loses that momentum, it will experience negative feedback, where people rush to sell before things worsen further.

I'm disappointed that Shiller didn't offer a suggestion as to what Bernanke could do.

Last year I provided some supply-demand diagrams to model the market dynamics of speculation that might be of interest to some readers: Speculation is the Key