Arnold Kling  

Shiller Interviewed on the Subprime Crisis

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Greg Mankiw has the 8-minute video. It's worth watching. Shiller is a very independent thinker. He says that what we need is more financial innovation, not less. He says that we should not have been trying to urge so many people to take leveraged positions in homes, and that we should not be trying to maintain high house prices. (He spells out this latter point more in his book.)

Contrast these eight minutes, which are enlightening and educational, with the eight minutes of Furman and Holtz-Eakin that Mankiw linked to and I snarked about.

It is not that Shiller is fantastically better as an economist than those two. But political campaigns truly cause evil things to happen.

This year, the campaign feels to me like a popular movie that, like most popular movies, is not to my taste. While the Sarah Palin character adds melodrama and is well played, the overall script does not appeal to me. It includes too many promises of energy independence and no mention of unsustainable entitlement spending. And nothing remotely as thought-provoking as what Shiller has to offer.

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COMMENTS (7 to date)
Jim Gannon writes:

He seems to be saying a lot of silly things too. Around 7 minutes into the interview, he says that the recent economic stimulus refunds were a good thing. He also implies that the creating the SEC, FDIC, Freddie Mac and Fannie May were good things. Am I missing something or do you agree with these comments?

He also says "we should" a lot which is a red flag for me.


Arnold Kling writes:

I disagree with Shiller on a lot of things. But I give him credit thinking through problems, not trying to score ideological points.

Jim Gannon writes:

Roger that. His idea for a new loan instrument did sound interesting.

bee writes:

The idea is interesting and Shiller is on target in looking forward as to how markets can address this type of problems.

shayne writes:

The only thing I found at all compelling about the Shiller commentary was his observation that the last few years were marked by a "colossal failure of risk management." And I think most everyone already knows that - with the possible exception of Shiller. The video shows Bush and Greenspan "cheering on" the housing boom of the early decade. That is true of both of them, but it's a fact-out-of-context - EVERYONE was "cheering on" the housing boom!

Financial institutions - due to the revenues generated by increased home-buying activity.
Speculators AND existing homeowners - due to the rapid asset appreciation that was occurring.
"Poor folks" - due to home ownership being supposedly "within reach".
Governments (all of them) - due to their increased tax revenues, both from property tax on inflated asset values, and from increased general economic activity.
And, Politicians - for all the reasons cited above.

A home mortgage is inherently leveraged, and thereby inherently risky. If I understood the short-term (taxpayer bailout/risk-assumption) and long-term (wider base of risk assumption, with the home buyer rendered relatively more immune from risk) solutions Shiller proposed, I can't help but suspect they would result in the same environment that caused the sub-prime phenomena in the first place. They both seem to encourage "colossal failure of risk management", particularly on the part of home buyers.

I'd advocate the following solutions:

1.) Short-term: Nothing required in terms of government activity or policy - the market is already dealing with it. The housing markets are adjusting prices down in order to clear, just as markets do when left alone. Financial institutions already have enormous incentive to re-negotiate with valid owners - it's either that, or foreclose and bear the related costs, including selling foreclosed property in a declining market. And the market already provides mortgage insurance vehicles as a hedge against risk. If they are insufficient/ineffective, that is where financial/insurance innovation might be applied.

2.) Long term: Since mandatory primary education is already in place in the U.S., add to its mandate to provide primary education in managing one's finances. Teach every "schoolee" at least the fundamentals of financial risk management and what a "colossal failure of risk management" can entail. There used to be a required course[s] in "Home Economics" - how about a required course in "Life Economics"? I'd estimate 1 year (mandatory) would at least help. And I'd be happy to assist with curriculum development (I teach college level econ, management and finance now.)

The U.S. in particular, with the rest of the world following closely, has developed and implemented the most powerful, sophisticated financial markets ever known. Yet even in the U.S., the school system "graduates" young adults with little or no sense of it, how it works, how to benefit from it, or how to even survive within it. It's the functional equivalent of handing the kids the keys to a new Corvette and a credit card for gas - with no driver's training - and telling them to go play on the freeway.

Shiller's solutions seem only to propagate the notion that it's okay for folks to engage in "colossal failure[s] in risk management" - after all, the government (taxpayers) will assume your risks for you, or compel someone else to assume them for you. I just can't be impressed by that.

Max M writes:

Well said Shayne. I think your book would compete well against Shiller's, were you to write one ;)

shayne writes:

Thank you, Max M.

Perhaps, instead of just criticizing other's work here, I should get off (or on) my tushy and publish my own - and subject it to critics like me. Maybe someday ;)

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