Robert Shiller on the real estate bubble and more n the Atlantic Monthly:
Many culprits have been fingered for the housing crisis we’re in today: unscrupulous mortgage lenders, dishonest borrowers, underregulated financial institutions. And all of them played a role. But too little attention has been paid to the most fundamental cause, the same one that was at the root of the many booms and busts that Sakolski chronicled years ago: the contagious optimism, seemingly impervious to facts, that often takes hold when prices are rising. Bubbles are primarily social phenomena; until we understand and address the psychology that fuels them, they’re going to keep forming. And unless we apply that understanding to the bubble we’re trying to recover from, we risk calamity.
Bubbles are a lot like epidemics. Every disease has a transmission rate (the rate at which it spreads from person to person) and a removal rate (the rate at which those individuals recover from or succumb to the illness and so are no longer contagious). If the transmission rate exceeds the removal rate by a certain amount, an epidemic begins. Speculative bubbles are fueled by the social contagion of boom thinking, encouraged by rising prices ...
There’s another, more urgent reason to focus on the idea of social contagion today. Like booms, many busts are magnified by group thinking. And once busts become severe enough, they prompt changes in the national mood that ramify well beyond economic affairs. ... We recently lived through two epidemics of excessive financial optimism. I believe that we are close to a third epidemic, only this one would spread irrational pessimism and mistrust—not exuberance. If that happens, our economic problems will become much worse than they need to be, and our social problems will multiply. Only if we heed the lessons of the boom can we keep the bust from causing lasting damage.