US expert warns of fresh shocks

Eoin Callan
Financial Times
Thursday September 20, 2007

Fresh economic shocks on the scale of the current credit squeeze will occur if US house prices continue to fall, one of the country’s leading housing experts warned on Wednesday.

Robert Shiller, a Yale university economist, told a US congressional panel that he feared “the collapse of home prices might turn out to be the most severe since the Great Depression”.

“The decline in house prices stands to create future dislocations, like the credit crisis we have just seen,” he told the Senate’s joint economic committee.

The warning underlines an increasingly widespread view that the turmoil in financial markets and tightening lending conditions are early consequences of a slump in the US housing market that is gathering momentum.

Mr Shiller, who designed the respected Case-Shiller house price index and predicted the bursting of the dotcom bubble in a bestselling book, said that while there had been a focus “on lax and irresponsible lending standards, I believe that this loss in housing value is the major ultimate reason we see a crisis today.”

Alan Greenspan, former Federal Reserve chairman, told the Financial Times this week that double-digit falls in house prices from their peaks would not be surprising. A fall in house prices on that scale would be unprecedented in US history and would have an economic cost several times greater than the meltdown in the subprime mortgage market that triggered the current financial crisis.

The Center for Responsible Lending has predicted that foreclosures on subprime loans will lead to a cumulative loss of $164bn (€118bn, £82bn) in home equity. Investment banks have suggested the costs to financial institutions could be more than $300bn.

The joint economic committee heard from experts who said a 15 per cent fall in house prices would wipe out $3,000bn of household wealth.

Alex Pollock, a fellow at the American Enterprise Institute, said: “Residential real estate is a huge asset class, with an aggregate value of about $21,000bn, and is of course the single largest component of the wealth of most households.

“A year ago it was common to say that while house prices would periodically fall on a regional basis, they could not on a national basis ... Well, now house prices are falling on a national basis,” he said.

Mr Shiller said it was “difficult to predict the depth, duration and all of the consequences” of the worsening housing slump.

“The Federal Reserve will undoubtedly take aggressive actions, which will mitigate its severity. But, if home price deflation persists or intensifies, they may discover that the Achilles’ heel of this resilient economy is the evaporation of confidence that can accompany the end-of-boom psychology,” he said.

Senator Charles Schumer, chairman of the joint economic committee, criticised the handling of the subprime crisis by the Fed and the Bush administration.

“Despite all the reassuring statements we’ve heard from the administration that the impact of this mess would be ‘contained’, it has not been contained, but has been a contagion that has spread to all sectors of the economy,” he said.