Shiller's Case: Unruly Children, Insolvency Sponges, Futures Markets for Unemployable Losers, and More

Robert Shiller's book The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It came out last summer, and since then the diligent co-creator of the highly regarded Case-Shiller Home Price Index has already published another book. But Subprime contains provocative stuff, all of it nicely phrased, and a good summary of a well-thinking type of moderate interventionism that informed much of the 2008 bailout season. I'll avoid saying which of the following highlights I think are good ideas and which are completely absurd; I think there's some of both:

Page 40

Ben Bernanke, then chairman of the President's Council of Economic Advisers, said in 2005: "House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas."

Page 43

Perhaps [former Federal Reserve Chairman Alan Greenspan]'s lack of attention to bubbles reflected, at least in part, an overly strong ideological alignment with some of the views of his former mentor, the philosopher Ayn Rand…. But a tendency to base one's self-esteem on a belief in the possibility of economic success through individual action goes far beyond the admirers of Ayn Rand.

Page 45

In a survey that Karl Case and I conducted in 2005, when the market was booming, we found that the median expected price increase among San Francisco home buyers over the next ten years was 9% a year, and the mean expected price increase was 14% a year. About a third of the respondents reported truly extravagant expectations -- occasionally over 50% a year.

Page 52

When in October 2006 I participated in a panel sponsored by the Yale Investment Club, I shared the dais with Frank Nothaft, chief economist at Freddie Mac… I asked him if Freddie Mac had stress-tested the impact on itself of a possible housing price decline. He answered that he had, and they had even considered the possibility of a 13.4% national drop in home prices. I protested: "What about the possibility of a drop that is bigger than that?" He answered that such a drop had never happened, at least not since the Great Depression.

Page 58

What is different with the recent bubble, in comparison with earlier bubbles, is that the "new era" story is one of economic pressures that will raise the price of every available piece of real estate. Real estate bubbles from previous times have always been relatively local…

Page 64

It used to be that the underlying land typically constituted only 15% or so of the value of a home in a typical city. So people thought of their homes as depreciating manufactured goods, like cars and boats, which require a lot of upkeep and eventually go out of style. But now that land value (defined as the price of a home minus the estimated cost of building the structure) is often over 50% of home value, we are starting to think of houses as if they are land.

Page 70

If the real prices of homes had risen at just 3% a year over the past century, then we could generally not afford houses that are any better or bigger than we could then. But we know that homes have in fact gotten much larger and better.

Page 84

The idea that public policy should be aimed at validating the real estate myth, preventing a collapse in home prices from ever happening, is an error of the first magnitude. In the short run a sudden drop in home prices may indeed disrupt the economy, producing undesirable systemic effects. But, in the long run, the home-price drops are clearly a good thing.

Page 88

In the nineteenth century the preferred expressions were the "sponge of insolvency" or "premium on hazard and overtrading." But the term bailout is more intense, with its suggestion of abandoning an aircraft in midflight -- leaving it to crash and burn on someone else.

Page 94

Let's return once more to the metaphor of the child who will not eat dinner at the appointed time. Now imagine that there lives in the same house a grandparent who is suffering from a painful disease or is mentally impaired; perhaps one of the child's parents is in some emotional distress. Having a child throw a tantrum in this situation would be too emotionally draining on the whole household. A wise parent might indeed bail out the unruly child now, and think later about lessons to be learned.

Page 104

In an attention cascade, economic events or problems become the subject of more and more talk and of stories in the media, until they come to dominate public thinking…. In fact, long-lasting and severe changes can take place before conventional economists have any clue about them.

Page 106

While it is natural to emphasize the unfairness of bailouts to those who do not receive them, judgments of what is fair and unfair are far from clear-cut. There is an inherent unfairness in our economy, evidenced by its sharp income inequalities.

Page 115-116

There used to be tremendous instability in the banking sector. For example, there were severe U.S. banking crises in 1797, 1819, 1837, 1857, 1873, 1893, 1907, and 1933. These problems were largely fixed by a number of institutional changes over the years, notably the creation of the Federal Reserve System in 1913 and the New Deal reforms of the early 1930s.

Page 122

Government promotion of a fundamentally improved information infrastructure can capitalize on the advances we have made in recent years in both information technology and behavioral economics.

Page 125

The government needs to … effectively subsidize fee-only, comprehensive, independent financial advice for everyone.

Page 128

There is, of course, the question of how many will actually avail themselves of financial advice, even if its cost is reduced considerably. We will only know the answer if we set the subsidy in place.

Page 129

The second step in correcting the inadequacies of our information infrastructure, as outlined by legal scholar Elizabeth Warren, would be for the government to set up what she calls a financial product safety commission, modeled after the Consumer Product Safety Commission.

Page 130

The third step in renovating the information infrastructure is to set up standardized default-option financial plans that operate well when people are inattentive and fail to act.

Page 138

The fifth step toward an improved information infrastructure is for the government to subsidize the creation of large economic databases on both individuals and all firms, under a protocol that allows this information to be used to develop risk-management contracts and at the same time assures privacy.

Page 140

So many people find understanding our economic system a challenging task. To help them, the government needs to set up a new system of economic units of measurement. This part of the subprime solution would be a truly revolutionary step, akin to the creation of the metric system after the French Revolution.

Page 142

I would give these inflation-indexed units a simple name, baskets, to make clear that they represent the value of the market basket of goods and services upon which the consumer price index is calculated. If sellers name their prices in baskets, they are effectively asking to be paid in terms of the real goods and services that underlie the consumer price index -- to be paid in real things rather than unstable currency.

Page 150

If we did have a liquid market in real estate futures by city, then any skeptic anywhere in the world could, through his or her actions in the marketplace, act to reduce a speculative bubble in a city, for such a bubble represents a profit opportunity for short sellers.

Page 154

Markets for occupational incomes -- such as futures, forwards, swaps, and exchange-traded notes -- will ultimately make it possible for people to hedge their lifetime income risks.

Page 157

A new kind of home mortgage that I call a continuous-workout mortgage would have terms that are adjusted continuously (in practice probably monthly) in response to evidence about changing ability to pay and changing conditions in the housing market.

Page 161

Home equity insurance contracts can be written on the market values of homes in a metropolitan area, protecting homeowners against declines in the value of their homes within their local markets.

Page 164

Livelihood insurance would be a significant step toward addressing the consequences of job loss.

Page 169

We could eventually find ourselves forgetting that the kind of massive financial instability infecting our everyday lives is even a potential problem. Modern finance, applied democratically, can relegate these problems to history just as modern medicine, applied widely, has left us forgetting that epidemics of yellow fever and diphtheria ever raged among us.