|The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It
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The subprime mortgage crisis has already wreaked havoc on the lives of millions of people and now it threatens to derail the U.S. economy and economies around the world. In this trenchant book, best-selling economist Robert Shiller reveals the origins of this crisis and puts forward bold measures to solve it. He calls for an aggressive response--a restructuring of the institutional foundations of the financial system that will not only allow people once again to buy and sell homes with confidence, but will create the conditions for greater prosperity in America and throughout the deeply interconnected world economy.
Shiller blames the subprime crisis on the irrational exuberance that drove the economy's two most recent bubbles--in stocks in the 1990s and in housing between 2000 and 2007. He shows how these bubbles led to the dangerous overextension of credit now resulting in foreclosures, bankruptcies, and write-offs, as well as a global credit crunch. To restore confidence in the markets, Shiller argues, bailouts are needed in the short run. But he insists that these bailouts must be targeted at low-income victims of subprime deals. In the longer term, the subprime solution will require leaders to revamp the financial framework by deploying an ambitious package of initiatives to inhibit the formation of bubbles and limit risks, including better financial information; simplified legal contracts and regulations; expanded markets for managing risks; home equity insurance policies; income-linked home loans; and new measures to protect consumers against hidden inflationary effects.
This powerful book is essential reading for anyone who wants to understand how we got into the subprime mess--and how we can get out.
- Sub Prime ----too late
Thie book tells the reader what we already know about the sub-prime lending problem..... stupid buyers and greedy lenders. Don't waiste your time reading this one....more info
- Disappointing, esp. from Shiller
I got the impression that this book was thrown together, in part from earlier published work, to catch the wave of public interest in the subprime meltdown. Much of the content seemed just odd and unrealistic, and Shiller's etymology for "bailout" is ludicrous. (Has he never heard of bailing out a water-filled boat? Or used an American dictionary in preference to the OED? Bailout, in reference to a financial rescue, has been flagged as an Americanism for decades in Webster's New World Dictionary, College Ed.)
His solutions seem too academic, airy, and remote to be of much practical interest to anyone but another academic. I expected better from the author of the wonderful Irrational Exuberance.
Mercifully, it is short and for the most part well written, even if some sections (for example the treatment of the "basket" as an inflation adjusted currency) are befuddling (to this layman, at least)....more info
- Three stars for the layman but only one for those with academic/professional backgrounds in the subject
In terms of the value, this book would rate three stars for the layman but only 1 for those knowledgeable in the field.
During the first approximately 100 pages of this 180 page book, Schiller describes what lead to this debacle and draws analogies between the current situation and past in both the U.S. (i.e., events leading to the Depression, the Savings and Loan crisis leading to the formation of the Resolution Trust Company, etc.) and overseas (i.e., the 1990s bubble bursting in Japan and the Swedish banking sector crises of the 20 years ago). What he describes should be well known by anyone who has had an undergraduate course in U.S. Economic history, reads a sophisticated financial newspaper or magazine (i.e., Financial Times or Economist) and/or is a financial professional. Hence for this group the first 100 pages would have very little value. For layman without this background, however, this knowledge would provide good perspective.
Where the book really is weak, though, is the remaining 80 pages where Schiller provides his "solution(s)". This is what he calls the "democratization" of the financial market. The important points of this consist of:
a) The provision of financial advice to "the masses" through subsidized professional financial advice.
b) Adding more "bite" to government regulatory bodies (i.e., SEC).
c) the creation and utilization of financial instruments that provide insurance against fluctuations in home prices, economic conditions and peraonal economic conditions (i.e., unemployment). Examples of such financial instruments provided by Schiller include options and futures indexed to housing prices, Government debt instruments that are counter cyclical and instruments that provide the ability to hedge against personal financial circumstances.
Each of the above need to be examined in detail. With respect to the first, it seems highly unlikely that high quality professional financial advisement services that are unbiased (i.e., don't provide advise geared to selling financial products that do not necessarily coorespond to individuals' econommic situations as opposed to the commissions of the financial advisors) can be provided at a cost effective price that even the lower income ranks can afford. Any such labor intensive service can only be provided (in general), cost effectively, by those with limited educations and/or poorly trained backgrounds. A good analogy would be going to H&R Block. You pay relatively little there but you end up with high school graduates who, in general, have very limited qualifications. The end result would be mediocre advise. In a recent article in the New York Times the IRS was quoted as stating that 2/3 of tax forms prepared by tax preperation firms had contained errors. If these firms cannot succeed in providing relatively simple tax assistance how can they provide more complicated financial advise on how to hedge home, retirement and other assets? Even if they were all highly qualified this would still be a problem. The events leading to the current bubble bursting, as well as those of the late 1990s, caught many highly educated professionals such as Alan Greenspan and Bernanke by surprise. If they failed how can the less qualified be expected to perform better? This simply does not seem logical.
With respect to Schiller's recommendation to beef up government regulatory agencies such as the SEC, this would seem the most feasible of all. SEC funding can be increased, penalties increased, and litigation can be loosened to permit an increased deterance of corporate mafleasance by accounting, investment banks and other financial institutions. This recommendation is very realistic.
Schiller's third recommendation, the utilization of financial instruments to mitigate against fluctuations in housing prices and individual economic circumstances, sounds very nice theoretically but is hard to achieve in reality. With respect to housing price fluctuations, options futures on housing prices can be used (they already exist) but they require extensive knowledge in finance and they are relatively expensive to purchase when housing prices are on the decline (when they are needed most). Hence not a solution that seems very practical beyond homebuidling conglomerates. But even they did not make very extensive use of them.
With respect to financial instruments that can be used to mitigate against individuals' economic fluctuations (i.e., unemployment) there are other problems. First they do not exist. Secondly, even if they did (and why they are not provided by the private sector to begin with), there would be to much of a problem relating to moral hazard. Individuals can purchase such insurance then either intentionally put themselves out of work or not do enough to prevent unemployment. If one has insurance against all (or nearly all) income losses stemming from unemployment the incentive would greatly decrease to take steps to prevent unemployment.
In short, only Schiller's recomendation to beef up regulatory agencies seem realistic and feasible (at least in the foreseable future). ...more info
- Subprime Solution - Robert Shiller
The shipping source I think in England was far below your standard, they missed shipping dates and informed well after the Book should have arrived. Their email responses are not "customer service friendly", I will not order a book from them again, if they are the sole choice I will go elsewhwere....more info
- Clear and insightful book on the subprime crisis
Robert Shiller's book doesn't warrant some of the negative reviews on here.
In an age of talking heads and pundits who argue more so on the basis of philosophy than on any factual evidence, this book's clear and evidence based examination of the subprime crisis comes as a refreshing alternative. Shiller, a Yale professor of economics, overcomes any temptation to over complicate or to talk down to the reader and gives a frank and detailed assessments of the current mortgage mess, the reasons we're in this crisis, and the possible short and long term solutions.
While Shiller explicitly states his view on framing a short term bailout in the early chapters, he has not written a policy paper. Instead, the book is a collection of thoughts and ideas of what would strengthen our financial institutions for the future - ideas like cpi adjusted standards of accounting (unidad de fomento) to weather periods of inflation/ deflation, subsidized financial planning to encourage savings and prevent speculation, and government sponsored financial watchdogs to assist the private investor.
Interestingly, Shiller anticipated the anger and the frustration that many average mainstreet americans feel about the current crisis. He warns against excessive finger pointing at officials, borrowers, and lenders. For one thing, they were all trapped in a flawed incentive system. He points to the disaster of the German reparation after WWI as a warning against letting the desire to punish go rampant and cloud pragmatism in making policy. Instead Shiller makes practical recommendations and suggests that once we are out of the current mess, we should structure our financial institutions to prevent future crisis, design insurance against economic/financial downturn, and actively integrate economic theory in public policy.
A more controversial topics that Shiller touches on is the role of future markets and derivatives. Here, instead of opting with most financial writers who are now so enchanted with the Buffetian quote about mass financial destruction, Shiller recommends more derivatives and more future markets as a part of the "subprime solution." Although I am convinced by his argument that future markets with enough liquidity will reduce risk and offer hedging insurance against market disruptions, I am rather disappointed that Shiller did not offer an analysis of the argument that derivatives were a part of the "subprime problem." If more financial engineering is in fact a long term solution to financial problems, Shiller should have at least addressed the current negative perception with a sentence or two. I hope that this will be corrected in future editions.
Even though "The Subprime Solution" is not an all encompassing treatise of the current financial crisis, it offers strong insights, readability, and wisdom in a time of uncertainty....more info
- The Troubles with Bubbles
Subprime. How often did you use the word three years ago? Today it is all over the news. But what, exactly, is "The Subprime Crisis"? How serious is it? Who is responsible? And what shall be done to solve it?
If you are looking for answers for any of these questions, than, alas, "The Subprime Solution", which comes hyped by some great economic writers (like Gregory Clark, of A Farewell to Alms: A Brief Economic History of the World (Princeton Economic History of the Western World) fame) is not a book for you. Shiller's analysis of the crisis is unsatisfactory, and his solution either mundane or speculative - with serious problems which Shiller overlooks.
Shiller informs us, at great length and repeatedly, that we are facing an extreme crisis. He calls it a "historic turning point in our economy and our culture"(p.1) and repeatedly compares it to the economic reparations inflicted on Germany after the Great War, and to the Great Depression. Watch out for the Hoovervilles! Seriously, such comparisons are unhelpful and unnecessary. The Subprime crisis is grave enough without comparing it to the Great Depression (is the Great Depression some sort of economic answer to Godwin's Law, which states that on every discussion, Hitler must at some point appear? Can't we ever talk about an economic crisis without channeling the nineteen thirties?).
But I digress. From approximately 1998 until 2006, the price of houses in the US rose much above their historical value, without any justification in terms of economic situation, the costs of construction, etc, (p. 36). Why did the prices rise? Well, because everyone thought that they would - and the expectations became self fulfilling prophecies. In short, there was a bubble.
But the bubble, as bubbles do, burst. Many lenders, who have offered mortgages to people based on the assumption that house prices would continue to rise, now have a lot of bad debt. Borrowers, who believed the same thing, now find it difficult to pay back their loans, and thus face the prospects of losing their homes. This problem is exacerbated by all sorts of "new" mortgages, especially ones with adjustable interest rates. As interest rates rise, people who used to be able to pay mortgages are no longer able to do so.
But why was there a real estates bubble, and not a bubble of, say, Tulips (as in the Dutch Tulip mania of the 17th century)? If Shiller knows, he's not sharing. Nor is he telling us how big a problem it is. At the time of writing US unemployment rate is approximately 6%, GDP growth is down and inflation up, but the US does not seem to face either a contraction or hyperinflation, but only a recession. Recessions are part of economic life, and probably altogether unavoidable (which is not to say that US economic policies were ideal or even adequate).
Following his non description of the crisis, Shiller offers one short term solution, six long term ones, and a general call for more sophisticated housing markets.
The short term solution is a bailout. How large a bailout, and of what kind? Shiller mentions several proposals for a bailout, but he does not critically evaluate them. Nor is it entirely clear who he plans to bail out. Most of the time it seems the bailout will target borrowers, but Shiller also says that "it is essential that the... cost of bailouts... not be dumped into the laps of a small set of investors" (p. 108). There's a lot of talk of "getting the bailout right", and a lot of historical analogies (to the Great Depression, of course), but very little description of right and wrong bailouts.
The six long term solutions - as I said earlier - vary from the mundane to the speculative. The mundane: Improving financial databases and financial disclosures (is there anyone who will disagree?) The speculative: Shiller suggests "default options financial planning", what is now commonly known as Libertarian Paternalism - the government will offer a basic option, which people can cope out of (Nudge: Improving Decisions About Health, Wealth, and Happiness). This is of course a useless measure in mortgages, as the mortgage lender drafts the contract, in which you'll sign away your "default options". Shiller therefore slides into good old fashioned paternalism, requiring a notary to approve of mortgages (p. 134). "Libertarian Paternalism" I like; Regular paternalism, not so much. Typically, Shiller does not discuss the costs of his proposal (a Notary would be open to negligence suits by every defaulting borrower, and thus would require a hefty fee, needlessly impeding the transaction). Two further speculative suggestions are (1) a "Financial Watchdog" -equivalent to a Consumer Product Safety Commission, and (2) tax deductions for financial advice. Both suggestions exaggerate the knowledge of financial experts, who are no better at divination than the rest of us. The "Financial Watchdog" (1) runs a great risk of becoming politicized (think about what the Bush administration has done with the EPA), and of being relied upon too greatly. Shiller offers no evidence that tax credits for financial advice (2) are likely to be taken up by the small consumers whom the scheme targets, and to his credit, he admits as much. That he nonetheless dreams of a post-tax-deduction Utopia, where "technology will carry us forward into new dimensions of democratized financial sophistication that we cannot now imagine", is odd (p. 129).
The most interesting long term suggestion is to stop pricing things in currency, and to start using "inflation adjusted currency" or baskets. The government would publish a daily rate of exchange between the basket and the dollars. All prices would be denominated in "baskets". On pay day, one would look at the daily exchange rate between the "basket" and the dollar, and pay dollars based upon that rate. Apparently, such a system works well in Chile.
Again Shiller does not discuss the costs of such changes, and thus it is difficult to know if it is worth the fuss. First, teaching people to use a new measurement system is hard. If you are reading this in your native tongue, you are unlikely to use the metric system, because two hundred odd years after the French Revolution, it is still not widespread in the English Speaking World.
Furthermore, Inflation is not all bad, and so eliminating it is not an unalloyed blessing. There are two advantages to inflation. First, it allows prices (especially wages) to adjust downwards. Most people vehemently oppose pay cuts, but they are more willing to forego raises in difficult times. Second, a point made by Milton Friedman of all people, is that because people buy many different things but sell only a few things, they notice more a rise in their income than moderate rise in prices. Seeing your income going up is emotionally and psychologically satisfying (see Money Mischief: Episodes in Monetary History).
At the end of the book, Shiller argues for the development of sophisticated financial instruments for the housing markets. If (like at least one of the Amazon reviewers) you think speculation was the root of the crisis, you are unlikely to approve. As a fan of free markets, I'm open to the idea. But financial markets for houses would necessarily be very different than the markets for other products. To give just one obvious example, the product in most speculative markets are standardized (gold, dollars, US treasury bonds) - But every house is unique; With a little imagination, one can foresee all kinds of complications that this little fact may cause. Maybe these complications can be resolved, but Shiller's superficial account makes them seem far too easy.
"The Subprime Solution" is not as bad as most books I give 2 stars to; it is not entirely devoid of value. Nevertheless, its superficial account, melodramatic style and general lack of usefulness stop me from rating it any higher....more info
- Shiller addresses everything except the actual fix.
Mr. Shiller seems to be firing on half his cylinders in his approach towards solving the "housing crisis". Just like countless economists, he misses the mark completely on just what caused the so-called crisis to occur in the first place. For anyone with even a basic comprehension of simple economics, the reason is incredibly simple: Affordability.
The whole subprime machine was created out of the desire to continually inflate prices yet maintain sales by introducing 'clever' lending products for consumers who without such products would have long run out of the financial means to buy houses to start with. Had such loans and lending practices never been introduced, the bubble would have corrected much sooner, prices would not have climbed as high, affordability would not have become such a major problem in large metros ( almost 10x annual income in places like San Francisco) and lastly, we would likely have already recovered from such a correction. But instead, the fall has been far more painful and extended.
The solution is not to make attempts to create even more "democratic", or creative lending solutions. By doing so would merely deliver us back to a similar era of (In Mr. Shiller's words) Over exuberance.The simple answer to all of this is that we must allow the bubble to deflate. Yes, this means pain. It means a lot of people will lose homes that they had no business buying in the first place. It means prices will fall further. But it also means that once the dust settles, new home buyers will have a chance to buy in a more healthy, affordable environment. It means a return to more steady, reliable growth and appreciation. It also means more stability in the financial industry.
So no- I 100% disagree with Mr. Shiller on this. We as a nation should not be in the business of shoring up faulty business with the very tactics that placed it into its current negative position. Instead, we need a return to sound financial principals less reliant on shady economics. We need a return to actual affordability. Why this is so incredibly difficult for politicians, specialists, advisers, and economists to admit is beyond me....more info
- Thoughtful, straightforward diagnosis and prescription
Robert Shiller, the prescient author of the book Irrational Exuberance, offers an insightful examination of the causes of the subprime mortgage crisis, and suggests a list of potential measures for the future. He lays the blame for the subprime crisis on the same oblivious fiscal attitudes that led to the technology bubble of the 1990s and the real estate bubble of the 2000s. Both bubbles involved excessive lending and resulted in severe losses for capital providers. His prescription for dealing with the crisis involves a range of policy measures. In the short term, he calls for bailouts for low-income borrowers who got drawn into subprime scams that they did not understand. For the long term, he proposes a new framework for financial institutions, more transparent information, simpler contracts, improved risk-management markets, equity insurance and home loans linked to income, among other measures. Both his diagnosis and his prescription will be controversial, no doubt, but getAbstract thinks his book is a necessary text for anyone who wants to understand what's happened, and how to survive it and learn from it....more info
This book is essentially divided into three parts. (1) How we got here (2) What to do in the short term and (3) What to do in the long term.
I found Shiller's account of how the subprime crisis emerged to be on the money. Shiller co-developed the Kay Shiller index, which measures the real increase in home prices and he point out that, between 1997 and 2006, real home prices (inflation adjusted) increase by 85% (p. 32). This sort of growth is clearly unsustainable and a byproduct of a massive and misguided group psychology event. He likens the subprime contagion to a disease epidemic, slowly creeping up and eventually spiraling out of control.
Shiller argues that a drop in home prices are necessary in order to restore equilibrium to the market. He writes, "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." (p. 85)
After grounding the reader in the nature of the problem, he offers up both short term and long term solutions to the housing crisis. His proposed solutions are left leaning and strike me as theoretically appealing but implausible in practice.
He argues for a Home Owners Loan Corporation, similar to what was seen in the 1930s. The HOLC would buy up toxic mortgages and help to stabilize the markets. He also believes that public infrastructure should help to subsidize financial advise, so that people know what they are getting into a priori. Finally, he proposes a continues workout mortgage, whereby one's payments would go down in the event of an economic downturn. ...more info
- An interesting but uneven treatment of the subprime mess
Robert Shiller, the creator of the Case Shiller Home Price Index, comes to the subprime mess with certified authority and insight. The first three chapters are well written and enlightening. His comments about the long term buildup of the housing boom and its effect on the national psychology of the bubble are on target; he must be taken seriously on the present threat to the social cohesion of the country comparing its rendering to the Great Depression and his comments about the amplification of the bubble by the media will find many believers in this country. His criticism of Alan Greenspan is temperate and gentlemanly in that academic manner. His critique of OFHEO in not doing its job in reigning in Fannie Mae and Freddie Mac flies in the face of OFHEO's bracing 2004 and 2005 reports to Congress. Shiller takes on the easy targets, ignoring the real scoundrels, Chris Dodd and Barney Frank, and its Democratic establishment which ruled Fannie Mae for years. He admits as much in the epilogue; eschewing "finger-pointing;" acknowledging with italicized emphasis that " there have been evildoers." It is just not the Yale way. ...more info
- The Crisis and financial democracy
Professor Shiller is a leading figure in behavioural finance and this boook will certainly maintain that prominent position. The book argues that free markets are both the cause and the potential solution to our current woes. In reading the latter part of the book I was constantly reminded of Friedman's "Capitalism and Freedom" with its warning that markets are more than just a great allocative mechanism, but also a engine to disperse political power from a narrow political elite. Many of Shiller's ideas for hedging house price risk have already been taken up (admittedly in a small way) via the Case-Shiller house price index. I think this book, especially in its latter part, can serve as a blue-print for a wider dissemination of "financial democracy" via disability insurance, etc. I have heard it said that the financial crisis has brought out the best of Gordon Brown as Prime Minister. It has certainly produced some of Professor Shiller's finest writing. Let us hope Brown and Shiller do not have cause for further improvement in the near future.
William Forbes (Loughborough Business School, England)...more info
- The man knows housing
In a nutshell, economic crisis ultimately was not caused by housing going down, but by its going up over so long a time that borrowers and lenders alike made unwise choices, making a crash inevitable. Why this happened when it did is not clear, although better regulatory oversight would have prevented it. The short term solution is subsidized mortgages. Like a stimulus, this merely transfers future purchasing power to the present, but is nonetheless necessary to fulfill the implied contract between a government and its citizens to reduce hardship....more info
- 3.5 stars-Shiller can't deal with the risk versus uncertainty issue due to his support for SEU
This could have been a major contribution to economic theory and history.Unfortunately,Shiller is unable to think outside the box of the basic neoclassical rational actor model of SEU(Subjective Expected Utility)theory ,and its extension in the form of the Tversky-Kahneman Prospect (Cumulative Prospect Theory )Theory that underlies the behavioral economics(finance)school of thought that has arisen since the late 1970's.Shiller makes it clear that he is an avid supporter of this school(Shiller,pp.117-120).SEU theory is actually a more advanced mathematical form of Jeremy Bentham's Benthamite Utilitarianism ,as expressed in his 1787 book, " Introduction to the Principles of Morals and Legislation".Bentham,the founder of neoclassical economics, asserted that all rational,and even some irrational, human decision makers are able to accurately calculate the outcomes of their actions .However,he failed to present a method describing how such calculations were made.Modern neoclassical economics filled this gap by combining the Ramsey-de Finetti-Savage subjective theory of probability,based on the premise that all probability calculations are precise,exact,accurate,unique,linear,additive,single number calculations, based on the addition and multiplication laws of the probability calculus,combined with the expected utility theory of Morgenstern and Von Neumann,which claimed that all utilities can be shown to also be exact,precise,linear,additive calculations.Neoclassical economist Herbert Gintis gives a good summary of the neoclassical SEU theory :"...the model can be shown to apply over any domain in which the agent has transitive preferences " so that " there is a probability pi subscript,0<=pi subscript<=1 such that the agent is indifferent between Ai subscript and a lottery that pays A1 subscript with probability pi subscript and pays An subscript with probability 1-pi subscript.Clearly,these assumptions are extremely plausible "(Gintis,2004,Politics,Philosophy,and Economics,3,p.40).Unfortunarely,this is not the case.Gintis has presented an abbreviated summary of Savage's sure thing postulate that both Keynes(A Treatise on Probability,1921,p.315,ft.2)and Ellsberg(Quarterly Journal of Economics,1961) showed required that the decision maker would have to be able to specify a complete information set in order to specify a single ,unique probability distribution.Keynes expressed this by the condition that the weight of the evidence,w,equalled 1.A weight of evidence between 0 and 1, 0were irrationally using heuristics and rules of thumb,instead of the mathematical addition and multiplication laws of the probability calculus, that a rational decision maker would use,rather than recognizing that the experimental subjects realized that their information base was incomplete so that w and rho were less than 1.In cases of uncertainty /ambiguity ,where w or rho are less than 1,it is irrational to attempt to use the mathematical laws of the probability calculus ,which only work if w or rho are equal to 1.This was exactly the same point made in 1931 by Keynes in his review of Ramsey's subjective theory of probability in the journal the New Statesman in 1931 .SEU theory can only deal with situations of risk(w=1,rho=1).It is not able to deal with situations of uncertainty /ambiguity/vagueness.
Shiller constantly refers to the need to better manage risk through the mathematical risk models used in " modern " finance theory .These risk models[VAR(Value at Risk),CAPM(Capital Asset Pricing Model),and the Black-Scholes Equation] all result in the use of some sort of normal probability distribution(joint normal,cumulative normal,bivariate normal,multivariate normal,log normal)using the mean and standard deviation(Variance-Covariance Matrix) to measure risk.Benoit Mandelbrot has demonstrated continuously for 50 years that none of the financial time series data supports the use of any type of normal distribution.The data supports the use of the Cauchy,Frechet,or power law distributions like the Pareto.Mandelbrot has correctly demonstrated that decision makers face the wild risk of the Cauchy and not the mild risk of the Normal.All 6 of the solutions proposed by Shiller on p.122, and discussed in depth on pp.123-169 of this book, can't deal with Keynesian uncertainty or Ellsbergian ambiguity or Mandelbrotian wild risk.The only way to deal with the uncertainty and lack of confidence ,created by the speculative and securitization behavior of the large Wall Street investment banks and the commercial banking system ,is a preventitive one-prevent the speculators from getting their hands on the bank loans that they need to leverage their debt position in the first place.This is the solution arrived at by both Keynes and Smith(See Smith,WN,1776,pp.260-340, especially pp. 339-340;Keynes,GT,1936,pp.321-327,338-353,and pp,374-377).It involves fixing the rate of interest at a low level permanently in the long run and applying a policy of credit restriction.There is only one reference to uncertainty in this book.Shiller puts uncertainty in italics on p.103:"Right after the 1929 crash,the forecasters,although they did not predict the depression that was to follow,expressed unusual uncertainty(uncertainty is in italics for emphasis)about the economic outlook.Romer believes that it was this uncertainty that led to the sharp contraction in consumer spending that ultimately caused the Depression ".(Shiller,p.103,2008).Unfortunately,none of his solutions,based on the standard neoclassical SEU risk models,that are taught universally in all economics and finance classes in universities and colleges throughout the world,including where Shiller teaches,can deal with the collapse in investor and consumer confidence because confidence is a function of Keynes's w,which is assumed to always equal 1 in the SEU theory.Keynes gave the correct solution on p.158 of the General Theory- " A collapse in the price of equities,which has had disasterous reactions on the marginal efficiency of capital may have been due to the weakening either of speculative confidence or of the state of credit.But wheras the weakening of either is enough to cause a collapse,recovery requires the revival of both(Keynes placed " both " in italics for emphasis).For whilst the weakening of credit is sufficient to bring about collapse,its strenthening,though a necessary condition of recovery,is not a sufficient condition."(Keynes,p.158,1936).None of Bernanke's current policies or of Shiller's 6 recommendations on risk management will have any impact on confidence whatsoever.
Shiller's position,in this book and the others he has written in the past,is that the problem is one of irrational exuberance combined with information cascades. "An information cascade occurs when those in a group disregard their own independently,individually collected information because they feel that everyone else simply couldn't be wrong ".(Shiller,p.47).Keynes had already shown that the reason this occurs is that each individual regards his w to be very low.This means that you are now dealing with uncertainty and not risk.Risk management techniques,no matter how mathematically advanced,will not be able to deal with this problem.
Shiller has correctly identified the problems of financial speculation and securitization.Unfortunately,his new risk management techniques would have no more of a chance of dealing with the wild risk of the Cauchy Distribution than an ice cube would have of not melting in the Sahara Desert.An ounce of Keynesian/Smithian prevention is worth more than a pound of risk management techniques build on the standard deviation of a normal probability distribution." Excessive Volatility" automatically means that you have to deal with uncertainty as opposed to risk.
The book should be purchased if you do not already have one of Shiller's other books in your library.Otherwise,it is more of the same.
- Provocative analysis of the financial crisis
Robert Shiller, Professor of Economics at Yale University, has written an intriguing book about the financial crisis.
He writes of the US housing slump in the 1980s, "All this could have been prevented if people had simply adopted inflation-linked mortgages, but the public seemed unable to grasp the concept." He seems to be blaming the public, for having imperfect information. But if markets only work when everyone has perfect information, then markets don't work.
Excessive lending and speculation in housing created the house price boom of the early 2000s. Shiller blames `the contagion of market psychology', a contagion without borders because of capitalism's global nature. But the cause was not `market psychology', but the globalised financial system which provided the opportunities and incentives for speculators. The system created the psychology, not vice versa.
Shiller proposes to revamp the financial system: improve the provision of financial information, extend the scope of financial markets to cover a wider array of economic risks, and create retail financial instruments to provide greater security to consumers. He defends the top executives in the financial sector and calls for extending and developing financial markets. But even more opportunities and incentives to speculate would lead to an even bigger crisis next time.
Yet he does make some sensible proposals, like improving insurance against unemployment and illness. He says that to restore confidence, capitalism must bail out the low-income victims of sub prime mortgage deals and support homeowners, to prevent mass evictions. He opposes bailouts to maintain high values in the housing market, stock market, land market or any other speculative market.
He points out that unfair land use restrictions benefit landowners by keeping land prices high, preventing new construction. We need cheaper land, so that we can build more homes.
But of course if capitalism could do all these good things, it wouldn't be capitalism.
- A fine and concise summary of the subprime crisis
This is an excellent summary of the recent events, and most of its underlying causes. Although readers with an economics background may find its conclusions debatable - and may therefore refer to other works, it is undeniable that Schiller's piece is well framed and thought provoking. On its recommendations, I would advise to reflect about the underlying principles that he is focusing on when making those: he is focusing on the lack of ability of the general public to understand and manage the price volatility that real state assets are subject to....more info
- not up to Shiller's standards
Small book, with large type and many spaces.
Out of date given the recent economic crisis.
Not very interesting....more info
- Interesting Perspective on the Financial Crisis
Robert Shiller's "The Subprime Solution" provides an interesting and important perspective on the financial crisis. While other commentators focus on the individual products and entities that contributed to the crisis, Shiller takes a broader view. He asks, "Why did so many people across America use risky adjustable-rate mortgages to buy houses they couldn't afford? Why did Wall Street clamor for collateralized-debt obligations based on these mortgages?" His answer: a flawed collective belief that housing prices in America would rise continually. This conclusion is important in itself, for it flies in the face of conventional economic wisdom. According to Shiller, investors are not eternally rational but subject to periodic infection by social contagions like the housing bubble.
Shiller complements this analysis with a visionary explanation of mechanisms that could be used to minimize the effect of real estate bubbles in the long run. While this explanation is brief (the book is well under 200 pages,) it leaves the reader with plenty to think about.
My only criticism is that the book could use more analysis of the psychology behind the current bubble. Shiller asserts that the expansion of capitalism in China and India somehow affirmed Americans' notion that the land available for housing is scarce and thus valuable. This just doesn't seem plausible. Americans are no doubt aware how Chinese growth can affect the price of commodities like oil, but it seems highly unlikely that Asian investors are going to start buying up plots of land in Pittsburgh and Peoria. Overall, however, the book is a great read. ...more info