BB: How did you first get into studying home prices? RS: I guess it started with Case, who published a 1986 article about home prices in Boston. He rediscovered the repeat method. It's a little like same store sales for retail. You want to measure price changes for houses by looking at changes of individual houses that were sold twice on different dates.
I started working with him, and we published a number of articles on it. A student of mine named Allan Weiss became aware of what we were doing, so we started a business of producing indexes. I thought these indexes would be important because we will eventually be settling financial contracts based on real indexes.
We thought there weren't any good home price indexes at the time. We started Case/Shiller/Weiss in 1991.
BB: How was it different than what was out at the time?
RS: [The National Association of Realtors index] is a just a median of home prices. The mix of houses sold changes through time; their numbers jump around. We thought we were a big improvement on that.
It came out that our numbers were better when we set up on the futures market at the Chicago Mercantile Exchange in May 2006. A futures exchange demands an accurate index. If financial contracts will be settled, you don't want [the index] to be jumping around in inexplicable ways.
We also partnered with Standard & Poors in 2006. Once we got them on our side, it really took off. It was perceived as having a lot of authority. They were also involved in verifying our facts and checking our indexes.
BB: Were you stunned by how quickly things came together for you in 2006?
RS: We founded the company in 1991. It has taken a long time. I'm surprised by the suddenness of it.
BB: Why is being aligned with Standard and Poors so important?
RS: The Chicago Futures Market urged us to do this. They said we'd have a lot more credibility working jointly with an established company like S&P.
BB: What's the importance of being on the futures market?
RS: Unless someone is signing contracts on it, it's just cheap talk. If no one is signing contracts on it, no cares whether it's right. Once you start signing contracts, it becomes suddenly important.
BB: What's your opinion of the current crisis? How did we get into it?
RS: The subprime crisis distracts everybody from thinking about new things. We've never had such a big boom before. We're in uncharted territory. The futures market predicts things will decline until 2009 and then bottom out and turn up.
BB: What will eventually happen?
RS: Prices and sales are not as connected as you might think. In the history of the United States, there has been a lot of volatility of sales and new-home construction-more than there was volatility of prices.
My suspicion is that home sales may recover, even in a market where prices are declining. As we work off the inventory, prices may still sag down. Yet there will still be opportunities for builders to build.
In Japan, in early '90s, construction went on even as home prices were falling. Prices are still very high. That's why I think they'll find lot of opportunities to recover from this slump.
BB: What kind of impact do indices, like yours, and the media have on the market as a whole?
RS: I think the media are tremendous propellers of the market, both up and down. We didn't have speculative bubbles until we had newspapers. The Tulip Mania in 1637 was the first known bubble. They had just invented newspaper. The newspaper kind of goads people and gets them excited. I think the news media played a role in this boom and is playing a role in the downturn as well.
BB: There are some criticisms of the index. What do you see as issues with it?
RS: We can't perfectly measure home prices. I'd get data about all the improvements in a home and filter that out. We ended up deciding there was too much guesswork. We don't really know how to correct for that. For long term, contracts, that's really OK.
BB: Does it cover enough markets?
RS: It covers about 70% percent of the country. We do miss parts of the country, and we'd like to include [them].
BB: Is there any other data you'd like to get?
RS: We rely exclusively on actual sales. We have to get enough data for repeat sales. We have thousands of indexes. I'd like to get more data. As time goes on, we'll gradually increase our coverage.
We spent years getting data sets. Sometimes we were not able to back them up. We learned some sources were big and unreliable. We needed checks to filter out errors. No one is giving us perfect data. It's a long process our company went through.
The consumer price index is the most important government contract. We should do the same thing with real estate that people do for the stock market. The S&P 500 is the basis of the world's biggest futures contract. MacroMarkets is as close as possible to the S&P 500 with our index.
BB: Your index gives the sales of bigger homes more value. Why is that?
RS: We deliberately made the bigger houses more valuated. For someone who is hedging the whole market, that's what he's hit by the most.
We have price tier indexes published. If anyone wants to write a financial contract in terms of one those, they're available.
BB: Why did real estate appeal to you?
RS: One thing I notice in academia is that everyone loves the stock market and there's tons of research on it, but there's comparatively little in real estate. I really think academics run in herds. I just don't understand why there's so relatively few going to real estate. I have this kind of deviant behavior. I always like to do things that other people aren't doing.
BB: What's your educational background?
RS: I went to the University of Michigan. I majored in economics and wrote for the Michigan Daily. Then I went to MIT.
BB: Are you married? Do you have kids?
RS: I'm married with two boys that are 22 and 25. My older son wants to be professor of economics, and my younger son wants to be a professor of philosophy.
BB: What did you father do for a living?
RS: My father [an engineer] was an entrepreneur, but not a successful one. He had a patent for an industrial oven. He started a business. Unfortunately, it never succeeded. I think I adopted his values. I wanted to do my own thing and not get swept along with other people.
The industrial oven was different. Maybe it was a little too eccentric. He wanted me to be an entrepreneur too, but I didn't start until he died. My wife thinks there's some subconscious effort to revive him.
BB: What did you learn about the business world from your father?
RS: It has this randomness. You may start the best construction firm in the country and do it at the wrong time. You could be destroyed. You hit the market at the right time, it goes to your head and you think you're a genius. That's the adventure of living.
BB: MacroMarkets obviously feeds your entrepreneurial bent. Tell me about it?
RS: MacroMarkets has 12 employees, and it develops price indexes for homes. We're not just a futures forum, we also do securities.
BB: How can your indexes benefit builders?
RS: Builders buy these huge inventories of land, but they don't hedge them. Builders who have new homes could attach price warranties. Especially in this market, it seems warranties could be a huge marketing success. If they did that, they would want to hedge it. That's where we come in.
If you're giving someone a price guarantee, you're selling them an option. They're already for sale on the Chicago Mercantile Exchange. Somebody has to pay for the option. It has a cost.
I think [offering a warranty] might be a good marketing strategy. It only comes into play if the house loses beyond a certain amount [of value].
BB: Have you talked to builders about it?
RS: Yes. They say it sounds interesting, but they don't act. Right now, it could solve a problem. Right now, they have all of this inventory. Why isn't moving? It's because people see the prices going down.
BB: Is there any other way it could help builders?
RS: They have land. They could just take their own position in the future market and hedge it. They don't do that.
BB: Other than MacroMarkets, what else do you do?
RS: I'm a full-time professor at Yale. I don't teach a real estate class. That reflects demand here. I teach foreign markets and behavioral economics. I talk about real estate in my classes. It's not a big thing at Yale.
BB: What were your influences?
RS: I study behavioral economics, which is the application of psychology and sociology to economics.
Our profession tends to be technical. It's technical in the sense that they tend to describe people as rational optimizing, calculating, when, in fact, there's a lot of craziness in people. We play on rules of thumb or hunches.
BB: What do you like to read?
RS: It's important to be well read. I read everything. If I have a personality trait, my mother once commented that I read everything
BB: How can builders best manage risk?
RS: In other fields, outside of real estate, risk management is fundamental. Futures markets are used by business to manage their risks. You don't put 1,000 tons of grain in warehouse and not hedge it. You can't predict what the market will do. You see builders put tons of land in their portfolio, and they don't hedge.
It's a question of expertise. If you're good at building houses, that doesn't make you good at speculation. You want to leave speculation to somebody else. Your business could be destroyed by a failure to predict the direction of the market.
In the U.K., there's the investment property database. People are starting to hedge commercial real estate there.
The culture is different in the building industry [in the U.S.]. It hasn't arrived yet. It's a very cyclical industry. It comes and goes. I'm fascinated by these waves of activity in real estate and other markets where it happens.
BB: What led to the problems we're now seeing in the residential real estate market?
RS: There was a buyer's panic, and the Fed was very loose in monetary policy in that period.
We were seeing financial innovations that weren't well understood. We had rating agencies make mistakes in the rating of mortgage securities. That helped propel the market. If people imagine these securities are safe, they put money in them. That goes into pushing the market. Regulating in the United States fell behind. Lenders were unregulated.
Any market boom is a matter of history. Whenever you ask historians, who take a broad and intellectual view of history, what caused some big event, they don't have easy answers. It's usually a confluence of events.
This could have turned out really ugly. We've seen a freezing of our credit markets at the same time housing prices are falling. That has the potential to accelerate the decline on home prices. It is happening somewhat.
BB: Will it get worse?
RS: The Congress hasn't enacted anything. The House passed bills, but the Senate hasn't. The President doesn't have authority to do a lot of things, while foreclosures are grinding on. We're not dealing with it in the most rapid fashion. That's why I worry that we will have a recession, and things may look substantially worse in the next year.
BB: Is there anyway the housing market get better?
RS: The London house market fell 5% in 2004. Pundits said it was the end of a bubble. Then prices went up. There was no really explanation. Everything else was booming. The psychology didn't sour as much. Now, everything is falling. You can find examples of home prices booming and busting within cities.
What's interesting about what's happening now is that it's looking less and less local. In some cities, we have no record of ever having a boom, like Phoenix and Las Vegas. They have suddenly become boom-and-bust cities. I think it's a change in our culture. We've come to think of housing as a speculative asset.
In the past, that was confined to a few special places. There was the Florida land boom in the '20s. The bust was attributed to the hurricane of 1926.
BB: What markets do you think are troubled right now?
BB: Why San Francisco? That one surprises me.
RS: Somehow, San Francisco has gotten the idea it's very special. I've always been a skeptic to how special the place really is.
Bank of America moved to Charlotte. Charlotte has never boomed and has really not fallen very much. Where would you rather live: San Francisco or Charlotte? The knee jerk reaction is that San Francisco is a very special place. Charlotte is starting to look like a special place now, too. San Francisco may be a classic example of people thinking they're too special.
BB: What about Texas?
RS: The Texas markets didn't generally boom as much. I think it's quieter. The oil crisis is probably still helping Texas.
BB: Is Florida still in trouble?
RS: We don't have futures on Tampa, but we have price data. Tampa is in for a big freefall as well.
Learn more about markets featured in this article: San Francisco, CA.