The Bubbleologist
Joshua Zumbrun 09.20.08, 11:30 AM ET
Washington, D.C. -
While many people were reading books anticipating the Dow Jones industrial average hitting 36,000, Yale economist Robert Shiller spent most of 1999 writing about the rapid–and, in his view, unsustainable–rise of stock prices. In March 2000, he published Irrational Exuberance; the same month, the dot-com bubble exploded.
In 2005, while banks were still enthusiastically peddling subprime mortgages, Shiller updated his book to extend his thesis to a clear bubble in real estate. We all know what happened there. Sept. 1, he released his newest book, The Subprime Solution, which argued that further and large-scale government interventions were going to be needed. (See review: “The Humpty-Dumpty Economy.”)
Who says you can't time the market?
Forbes.com caught up with Shiller in Washington, D.C., Friday to get his take on the housing crisis, the credit crisis, the massive government bailout coming down the pipeline, and what we need to do in the future. Some choice excerpts from our interview. Forbes.com: We had irrational exuberance going up–are we having irrational panic on the way down?
Shiller: There is an aspect of irrational panic, but it's not so clearly irrational. Banks are failing: Three of the biggest five investment banks have gone down. It's not so clearly irrational.
We find that [with housing] people are still bullish in the longer run … What is it that determines the peak? When people stop expecting prices to rise. It will turn up again when people lose their sense of pessimism and when the inventory [of unsold homes] is worked off.
What about stocks? In the second edition of Irrational Exuberance, you argued that stock prices were still too high by historical standards? Still the case? I think stocks are still overvalued. Price/earnings ratio is still high … I pulled a lot of my own money out of the market last year [and] earlier this year, fearing this would happen. I don't claim to know the market–it's inherently difficult–but I warn against this blithe optimism that stocks will always be the best investment.
People get this idea, after prices go up for awhile, that prices will always go up. That's what happened with housing.
Are the bailouts going to put a floor under it?
I don't think it puts a floor necessarily–home prices can still adjust down in spite of this. But it sounds like they're kind of doing what I proposed in my chapter [in The Subprime Solution] on bailouts.
Are you concerned this is going to get too expensive?
Well, the last big bailouts seemed not to have a cost. The HOLC [Home Owners' Loan Corporation, a Depression-era government entity that bought bad mortgages, much like the currently proposed institution to buy bad mortgage products], for example, ultimately bought 20% of mortgages, and the 20% they bought were a lot of the most compromised mortgages, and they still made a profit. That's not guaranteed; there were lots of factors that contributed to that … But the real cost would be the cost of the economy slipping into depression. It doesn't matter what your taxes are if you're unemployed.
But do we risk creating this “moral hazard”? If people and these institutions know they'll get bailed out, why be careful?
We have a social contract–an assumption in this country that we'll help each other. You know the pictures from the Great Depression–pictures of bread lines outside the church–we won't have that here. We have social insurance. It's not charity, it's a type of insurance to protect against a crisis.
If you added a new chapter to your book after the events of this week, what new topics you look at?
Ways to address this systemic risk. Maybe we need to think about having a monetary system less dependent on these institutions [that get “too big to fail”]. I have been thinking that antitrust might be enforced more rigorously with financial firms than non-financial. It's an idea I'm still thinking about.
In The Subprime Solution, you argued that one thing we need going forward is more futures markets. Are more of these complicated instruments part of a solution?
Well, we need to make futures markets more consumer-friendly. Encourage a challenge to the assumption that people should only be in stocks. Take oil: People buy oil, use oil. If we could get people to buy a product tagged to oil, if price goes up on oil, it costs more at the pump, but your whole portfolio has gone up.
This crisis I view fundamentally as a failure to manage risk. That's why I think the government should subsidize financial advice. There's a tax deduction, but it's only available to people who itemize their taxes. Change it so the subsidy is available to everyone. Even with widespread misunderstanding of the bubble, advisers would have still looked askance at people who took out these big loans.
What does it take for these proposals to get traction?
I've been to the Treasury and presented [ideas in the books]. They said, 'Yeah, it sounds like a good idea.' But there was no impetus for it. No momentum for change. This financial crisis is at least an opportunity for change. To get better ideas for risk management … I keep promoting these ideas and hoping someone will pick up on them eventually.