REIT - May/June 2010

situation is so unusual, really unprecedented, and there are hazards ahead. History is unpredictable. Little events can get magnified and have big consequences. We just don’t know.

REIT: Two big drivers of com-
mercial real estate are household
spending and employment
growth. What is your outlook
for each?
Shiller: We’ve seen a rise in the
savings rate that’s been holding for
some time, suggesting that people
are more wary than they were a
few years ago. Also, it might take
a long time for us to get back to
normal employment. Recent re-
cessions have had slow recoveries
and this one doesn’t seem likely
to be any better. We still have a
lending industry that’s not really
solid, and we’re still surviving on
government support that will be
withdrawn. We might not be back
down to 5 percent unemployment
for five or more years.

REIT: Distressed sales of commercial property haven’t happened in the large volume many expected. Why do you suppose that is?

Shiller: Commercial prices have declined quite a bit, if you look at the Moody’s and NCREIF indexes. I think people are worried that the decline isn’t over. The commercial real estate picture is very different from residential housing, so people may be waiting for a bottom, which might take another year or so.

It’s also plausible that banks
are trying to “pretend and ex-
tend” loans as long as possible,
although I don’t have any data to
support that. For them, it’s a bal-
ance sheet issue, and they don’t
want to dump property because
they are part of their local com-
munities and don’t want to dam-
age their local markets.

REIT: What you have said so far makes it sound like it will be a very slow recovery. What are the chances we will go into a 15-year slump like Japan in the early 1990s?

Shiller: The parallels to Japan are important. The Japanese economy had both a real estate bubble and a stock market bubble in the 1980s. When these major bubbles burst together, that led to a long slow period and crises in the banking system.

We’ve just done the same thing in the U.S., and it means a bad prognosis for the economy. But, remember, Japan’s “Lost Decade” (or lost decades as it now seems) was not a catastrophe. Real GDP disappointed, but actually grew between 1 percent and 2 percent a year, and the unemployment rate was not extraordinarily high.

That said, however, I do worry about a similar scenario for this country. We’re just not setting the stage for economic growth. Inspiring economic growth requires a sense of possibility and entrepreneurship. We get growth when people have new ideas and they set up new industries. You have to do that, you have to move forward and, in this economy, it just seems more difficult. That’s why I do worry the Japanese example may be relevant.

REIT: You have long advocated
the use of property derivatives
(index futures, options and
swaps) to hedge default and
price risks. And you co-founded
MacroMarkets to give investors
those opportunities. Why is that
so important?
Shiller: Risk management is a
very important and fundamen-
tal technology for improving
human welfare. It’s not just
cheap talk, it really works. Risk
should be transferable at mar-
ket-determined prices via liquid
financial products. We need
more innovation that stimulates
development of new markets
and products that facilitate risk
transfer within important asset
classes that have suffered from
limited liquidity. We’ll get price
discovery and derivatives prices
will tell us how to deal with risk.

REIT: Does this apply to both
commercial and residential real
estate?
Shiller: Commercial real es-
tate derivatives should be big.
Single-family real estate de-
rivatives should be even larger,
given the scale of the market
and the number and breadth
of housing market stakehold-
ers. Single-family real estate in
the U.S. alone is an $18 trillion
asset class, roughly three times
larger than commercial real
estate. Individuals and institu-
tions exposed to home price
risk still don’t have an ability
to easily hedge it, and portfolio
managers—whose portfolio
performance could benefit
from a single-family real estate