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Case-Shiller Index Faulted by Founder Robert Shiller? September 22, 2009

Posted by John Watch in News Feed.
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As reported in the Taipei Times, Economist and Ph D. Robert Shiller states that faulty models are one of the culprits that led to the lack of forecasting of the financial crisis by economists.   Shiller states these models lack the study of economic bubbles necessary to prevent crashes like our recent crisis one;

“The widespread failure of economists to forecast the financial crisis that erupted last year has much to do with faulty models. This lack of sound models meant that economic policymakers and central bankers received no warning of what was to come…the current financial crisis was driven by speculative bubbles in the housing market, the stock market, energy and other commodities markets. Bubbles are caused by feedback loops: rising speculative prices encourage optimism, which encourages more buying and hence further speculative price increases — until the crash comes.”

Real estate is Cyclical, Seasonal and Emotional, and Dr. Shiller appears to believe this as well. The “faulty models” caused an emotional stir that led to speculative prices until the crash.  The question is; which faulty models is Dr. Shiller referring to exactly?  

Is the Case-Shiller Index included in his broad statements?  Some economists argue that Case-Shiller is one of the faulty models that contributed to the increasing optimism and rising speculative prices in the market; as well as the panic and fear when the markets began to decline.  (Case-Shiller articles).

Developed in the 1980’s, the Case-Shiller Index evaluates trend changes in housing prices on a monthly basis of homes being purchased.  The index appears to be limited in the data it considers and analyzes, disregarding specific property data elements that assessment offices began to collect after its creation. Basic property data collected from public records such as school districts, location factors, square footage, age of home, land area, garages, bathrooms, views, waterfront, public amenities such as water/sewer and other property structures  appear to have limited influence in the calculations of the index.

For example, does the index adjust for the increased average size of a home built after 1995?  Using the same brush from 1980 and repainting over the same picture causes one to have an obscure view of a localized market like real estate.    In recent Index reports, Case-Shiller has inaccurately weighted metro areas suffering more foreclosures, which drag down the overall value of the Index.  Yet, it remains the leading index in the market; unaltered, unaccounted and underperforming during our most recent crashes.  

Dr. Shiller’s Index lacks the very ‘sound’ that he rebukes in his own article.

So can we expect an overhaul of the Case-Shiller Index?  Hindsight is always 20/20, and this article sounds more like a promotional piece promoting his latest books, than an honest challenge to fellow economists to revise models and develop more reliable measurement tools for the future.

When Dr. Shiller sold the Case-Shiller Index in 2001, what were the terms of the sale?  Did the conglomerate he sold to make adjustments to the index?  And the final question, what benefit did the conglomerate gain by having S&P promote the index starting in 2005?

Hopefully Dr. Shiller is taking his own advice and examining the fundamentals of the Case-Shiller Home Price Index and seeking ways to improve on a model, that when developed was the only one of its kind.  Today, many economists and computer technicians have access to so much data, that more complex models offer better solutions with limited influence from corporate rating organizations.

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