Groucho Marx and Property Bubbles

The commercial property market in London has been booming for several years.  The Bank of England is concerned about yet another property bubble building up.  The executive director for financial stability, strategy and risk at the Bank, Alex Brazier, warned in a speech last month that positive sentiment in the industry must be “tempered by experience of past business cycles”, so that we are not doomed to repeat previous booms and busts.  The Bank is constructing an index for banks and investors to show how prices compare with lending and cash flow.  If the market pays attention, there will be less risk of it getting carried away.

The existence of bubbles, whether in property or equities, creates problems for economists.  It is only two years ago that the Chicago-based Eugene Fama received the Nobel Prize for inventing the so-called efficient markets hypothesis nearly fifty years ago.  All public information is believed to be incorporated in the price.  So any extra material which the Bank, for example, provides is redundant.  Rational investors are already presumed to know it.

Less reverently, this view is sometimes referred to as the Groucho Marx theorem.  Groucho would never want to be in a club which would have him as a member.  And no rational agent would ever want to buy an asset which another rational agent is willing to sell.  Both sides of the deal suspect that the other has private information which has yet to hit the market.

The joke is not meant to be taken literally, but like many good jokes it does have a strong element of truth.  With economically rational investors, trading volumes would be low.  Instead, they are huge.  For example, in 2014, the total value of trading in the Standard and Poor’s 500 was $29.5 trillion, nearly double the size of US GDP.

There have been many technical attempts to explain why trading so large.  But they all struggle with the sheer scale on which trading takes place.  So economists are beginning to come to the view that markets might not be efficient after all.  Overconfidence could be an inherent feature of asset markets.  Overconfidence simply means having mistaken valuations and believing them too strongly.  Investors credit their own talents and abilities for past successes. They blame their failures on bad luck, rather than reducing their level of overconfidence.

A paper in the recent issue of the top Journal of Economic Perspectives by American economists Kent Daniel and David Hirshleifer provides tons of evidence to support this view.  For example, stock market trading increases during periods of high returns.  It was over 100 per cent of US GDP in the 1920, collapsed in the 1930s and 1940s, and rose dramatically during the 1990s until the crisis.

Much their evidence is on equities, most of which are readily tradeable.  So the returns on decisions which people make are obvious, and provide clear feedback.   The property market is much less liquid.  Overconfidence and mistaken valuations could build up even more.  The Bank’s efforts might not be wasted after all.

Paul Ormerod 

As published in City AM on Wednesday 11th November 2015

Image: Photo by Rex licensed under CC BY 2.0

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Alex O’Byrne, Associate at Volterra, is an experienced economic consultant specialising in economic, health and social impact, economic strategy, project appraisal and socio-economic planning matters.

Alex has led the socio-economic and health assessments of some of the most high profile developments across the UK, including Battersea Power Station, Olympia London, London Resort, MSG Sphere and Westfield. He has significant experience inputting to EIAs and s106 discussions as well as drafting economic statements, employment and skills strategies and affordable workspace strategies.

Alex is also experienced at economic appraisal for infrastructure. He was project manager of the economic appraisal for the City Centre to Mangere Light Rail in Auckland. He also led the economic and financial appraisals of the third tranche of the Transport Access Program for Transport for New South Wales, in which Alex developed and employed innovative methodological approaches to better capture benefits for individuals with reduced mobility.

He is interested in the limitations of current appraisal methodologies and ways of improving economic and health analysis to ensure it is accessible to as many people as possible. To this end, Alex recognises the importance of transparent and simple to understand analysis and ensuring all work is supported by a robust narrative.

Alex holds a BSc (Hons) in Economics from the University of Manchester and he was a member of the first cohort of the Mayor’s Infrastructure Young Professionals Panel.


Senior Partner

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Ellie is a partner at Volterra, specialising in the economic impact of developments and proposals, and manages many of the company’s projects on economic impact, regeneration, transport and development.

With thirteen years experience at Volterra delivering high quality projects to clients across the public and private sector, Ellie has expertise in developing methods of estimating economic impact where complex issues exist with regards to deadweight, displacement and additionality.

Ellie has significant experience in estimating the economic impact across all types of property development including residential, leisure, office and mixed use schemes.

Project management of recent high profile schemes include the luxury hotel London Peninsula, Battersea Power Station and the Nova scheme at London Victoria. Ellie has also led studies across the country estimating the economic and regeneration impact of proposed transport investments, including studies on HS2 and Crossrail.

Ellie holds a degree in Mathematics and Economics from the University of Cambridge.