Q & A with Robert J. Shiller

An interview with Robert J. Shiller, author of The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It

What are you trying to accomplish in The Subprime Solution?
I'm trying to train the public's attention on a set of goals government and business should adopt in correcting the current crisis as well as in promoting the conditions for a more vigorous real estate and financial environment in the future. There will be an ongoing public discussion consisting of thousands of policy proposals for correcting the real estate mess. I don't want to compete with these proposals. I hope to help galvanize this public discussion of the subprime crisis around a set of overriding goals.

You claim that one inspiration for this book was John Maynard Keynes' Economic Consequences of the Peace. How so?
Keynes' book The Economic Consequences of the Peace, written at the time of the Treaty of Versailles ending World War I, has long been an inspiration to me, because he employed economic thinking expansively for a broad, important, moral purpose, and at an important turning point in history.

When Keynes published this book, the Allied Powers were making a colossal mistake, asking Germany to pay more than she reasonably could in war reparations, and setting up a chain of events that could only lead to resentment. In fact, we now know that the resentment became so intense that it led to World War II.

This says something important about human emotions and drives, and a weakness that can cause people to careen blindly into huge catastrophes. In an important sense, we see the same human weaknesses again with the subprime crisis. The resolution to this problem calls for the kind of integrated thinking involving economic, political, and moral dimensions that Keynes brought to the crisis of his time. In this sense, Keynes' great book is an inspiration to me.

How is this subprime crisis related to the 2000 stock market trouble you discussed in Irrational Exuberance?
The stock market boom of the 1990s was an epidemic of investor enthusiasm that left its mark on our thinking. Its effects are very much part of the housing boom we have seen in the 2000s. In the 1990s, a great many of us learned to think of ourselves as investors, capable of identifying exciting investments. When the stock market soured after 2000, we lost much of our enthusiasm for stocks. But the enthusiasm that was bestowed on stocks shifted to the housing market. We still expected to make a lot of money as investors, but now in a different market. These expectations encouraged people to borrow too heavily to buy houses, and to get themselves in trouble.

You describe this as a GLOBAL financial crisis? How so? And how can the US coordinate its response with other nations?
Balance sheets of individuals, corporations, and governments are all interconnected through the international markets. We live in one world, both in terms of business arrangements and in terms of our culture. So far, the crisis has been largely centered in the U.S., though we have seen collateral failures of some magnitude in Europe as well as an international credit crunch. Further, we have seen housing booms in many places around the world, and these booms have the potential to collapse just as they have in the United States.

What is the single most important thing government can do now in response to this crisis?
In the short run, a new institution modeled on the old Home Owners Loan Corporation of the 1930s would go far in helping to shore up confidence in the mortgage market. There must also be some government attention paid to certain failing financial institutions. But government must first of all make sure that all people see themselves as fairly and consistently treated. Government actions must be taken with consistent purpose: to assure that as few people as possible feel that they have been mistreated and their grievances ignored and to prevent a systemic failure in the economy.

Another fundamentally important thing to do is to set up long-run institutions that will reduce the need for bailouts in future crises. We must use the occasion of this crisis to change our institutions and practices so that we are managing our risks better.

One of your proposed solutions is to improve the information infrastructure. Can you give an example?
The tragedy of the subprime crisis is that, at some level, it was all predicted by certain people who were in the know. It was well known among experts a few years ago that individuals were being given adjustable rate mortgages that they would not be able to afford after interest rates reset upwards, and that various financial institutions were getting into trouble with subprime loans. But this information did not get the public airing it required. Correcting these information problems requires a number of steps: better public support of information for financial consumers, better disclosure, better protocols for public use of data, better and broader markets, and better lending institutions. The ample provision of better financial information would represent a big first step toward inhibiting the creation of bubbles that cause crises such as the subprime problem.