Saturday, April 30, 2011

The Property Chute

It has been popular here in Ireland to explain the economic crisis by scapegoating a few individual actors - bankers, builders and politicians - and excusing the public. This attitude neglects the mad choices a great many individuals made during the boom to sink into debt and buy houses they could not afford. I wrote before that a conformist pro-housing zeitgeist in 2000s Ireland helped to inflate the bubble as ordinary people rushed to get on the 'property ladder'.

Dan Gardner's Risk: The Science and Politics of Fear references this conformist psychology to explain events in the US during the same period. He describes a study by economists Robert Shiller and Karl Case who asked housebuyers in San Francisco, 2005, whether they thought their new houses would rise in value, and if so, by how much?

The homebuyers surveyed by Shiller and Case not only expected home values to continue rising, they expected them to soar: The average expected increase was 14 per cent a year for a decade. 'About a third of respondents reported truly extravagant expectations,' Shiller recounts in his book The Subprime Solution. Some actually anticipated increases of over 50 per cent a year.

Of course the construction sector was actually a bubble about to pop, and the value of those homes collapsed over the following years. The property ladder was a chute.

Gardner argues that there could be psychological explanations for the whole experience, explanations that help explain the wider madness of house-buying crowds instead of scapegoating a few elite figures. In particular, he says that people were observing signals coming from others during the boom years, which reinforced a misplaced optimism in the profitibality of property: 'informational cascade': the fact that many people believe something convinces more people of that thing, which settles it for still more people, and so on.

Now add the pernicious influence of confirmation bias. Then add news media reporting that not only failed to expose mistaken beliefs but accepted, repeated, and amplified them.

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