Crisis Counsel

Stanley B. Resor professor of economics, Yale University

We have been in a spectacular boom in both stock and housing, and there's a psychology associated with that. That boom psychology brought us lower lending standards and a lot of wishful thinking about how easy it is to make money, and both real estate and stocks have been at record highs. But now they seem to be heading downward. We've seen home-price drops in most major cities in the U.S. Futures markets for single-family homes based on our index are predicting home-price declines ranging from 3% to 8% for the next year. And of course we've already seen big stock drops.

It's possible that we are at a major turning point, but I'm not sure. So far, I don't see any major change in investor psychology. I've been doing questionnaire survey work on homebuyers and stocks, and the results there differ from the futures markets. Regarding real estate, for example, we found that, among homebuyers in Los Angeles a few years ago, the median expected price increase for the next ten years was about 10% annually. With our latest survey this year, it's down to 5%. So expectations for buyers have diminished, but people are still expecting home prices to go up 5% a year, which is pretty good. The question is, Where will expectations go from here? If people lose their optimism, as indeed some have, they won't have the same incentive to buy housing. That could lead to a substantial drop in home prices.

My more optimistic thought is that lower housing and stock prices wouldn't necessarily be a bad thing. It makes housing more affordable and provides better opportunities for younger investors. It's not any kind of big disaster. It might slow down the economy and put us in a recession, but we'll emerge from it, and many people will be better off.