In Person: Bubble-spotter Shiller says consumers need more protection
Yale economist Robert Shiller believes the financial system can be reformed to better serve ordinary people.
Seattle Times business reporter
Robert J. Shiller
Job: Arthur M. Okun Professor of Economics, Yale University
Education: B.A. from the University of Michigan, 1967; Ph.D. in economics from the Massachusetts Institute of Technology, 1972
Family: Married to Virginia for 36 years; two grown sons
Quote: "Until recently, the prevailing economic theory was that markets were perfectly efficient in processing information and we should just leave them be and not worry about them. We've just learned that there is something to be worried about."
Previous In Person profiles
In the course of his four-decade career, Yale economist Robert Shiller has seen enough financial folly to make anyone cynical. Instead, he thinks the industry can and should be reformed to serve ordinary people, not just the superrich.
Shiller, who turned 66 on Thursday, is one of the founders of behavioral economics, the fundamental insight of which was that people aren't the perfectly rational value-maximizers of classical theory but fallible and imperfect creatures who invest on emotion and hunches, value a dollar today more than $1.50 tomorrow and go along when everyone seems sure real estate is a can't-lose investment.
Shiller's interest in economic bubbles led him to co-develop the widely followed Case-Shiller house-price index. He first warned about the danger of a housing bubble in 2003.
His book, "Irrational Exuberance," which argued that stocks had become perilously overvalued, was published in March 2000 — just as the Nasdaq was hitting its all-time high before the dot-com collapse. Small wonder that last year Bloomberg Markets named him one of the 50 most influential people in global finance.
But while many have damned the finance industry for rampant self-interest and a tendency to prey on people's flawed thinking for its own benefit, Shiller wants to overhaul it to make sure finance serves the greater good. The key, he says in his new book, "Finance and the Good Society," is to democratize finance — giving the rest of us access to the tools and techniques that rich folks have used for decades to raise capital and protect themselves from risk.
For instance, he suggests, the corporate income tax could be used to address the "too big to fail" issue by taxing massive financial firms at much higher rates.
Personal income-tax rates could be tied to statistical measures of income inequality, so that rates on higher incomes would rise along with inequality. Government could subsidize financial and legal advice for people of small means. Shiller will speak at Town Hall on Tuesday at 7:30 p.m. The Seattle Times talked with him late last month before his trip to the Northwest; edited excerpts from that conversation appear below:
Q: You call for more innovation in financial services, though it could be argued that the financial innovations of the last decade almost steered the country into a second Great Depression. Why?
A: The kinds of things that went wrong can be tied a little bit to innovation, but the primary thing that went wrong was the housing bubble we got into. The 30-year, fixed-rate home mortgage isn't the most advanced or innovative form of finance — if people's home value drops they can be in a lot of trouble, and they're not very diversified. People were overemphasizing buying a house rather than renting, but even if you do buy a house there are ways to do it so as to not leave people so exposed to the real-estate market.
The lesson should be to use modern tools of risk management. We need more flexible forms of mortgage, like mortgages that have a preplanned, built-in workout — for example, mortgage lenders would automatically reduce your (principal) balance if home prices fall, and then the lenders would use risk-management tools to protect themselves. That's the kind of thing I'm talking about.
The financial industry has its devices, just like the airplane industry, and every so often those devices crash. So when that happens we need to figure out how to make them better.
Q: Why do we seem so prone to bubbles and busts? Is the problem in our economic structures, or inside our heads?
A: It's both. In order to have a bubble, you have to have human psychology, which is a constant, but it also depends on institutions and regulations. We know that if you pack too many people into a stadium they're prone to stampede, so we have public-safety (occupancy) laws to prevent that.
Q: Can we trust the industry to move in this direction on its own, or does government need to be involved?
A: I hope I didn't give the impression that financial capitalism is uniformly benevolent. The problem, when you're trying to design an economic system, is what do you do about the aggressive, self-interested side of human nature?
The idea of a stock market strikes a lot of people as gambling, but then you have to reflect that people love to gamble. There's no perfect society, so we have to design it as best we can. It's not perfect, but lots of neat things happen here and there's so much variety. That's what financial capitalism does — it creates a way to incentivize people in such a way that things get accomplished, and you can pick where you want to be on the risk-return profile.
Q: But it seems like the financial industry — which, let's face it, has a lot of money and political influence — is always pushing to roll back whatever limits government places on its ability to sell whatever it wants to whoever it can convince to buy. How can we as a society make sure the industry stays innovative and competitive without handing over the keys completely?
A: One thing that bothers people is the political connections of business and the disproportionate influence of the financial-services industry, and that needs to be worked on more. We need lobbyists for the 99 percent, not just the 1 percent. There are some organizations like that [such as the Center for Responsible Lending and the Center for Community Self-Help], and in some sense, my book is a plea for the philanthropic community to support such groups.
But the kind of problems that aggressive financiers pose are mild compared to the problems that terrorists or invading armies pose. That doesn't mean we don't need to make improvements — for instance, we need better laws to prevent the buying of votes. But it's a difficult thing — I don't know anyone who has a miracle cure for the political system.
Q: Are the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Volcker Rule, which generally prohibits commercial banks from engaging in proprietary trading, examples of the kind of regulation you'd favor?
A: I think Dodd-Frank in the whole was a very positive development, but it's left us with a quagmire of things to do to implement it. The financial system is such a complex piece of engineering that you can't expect congressmen to know how to fix it. Dodd-Frank was a reaffirmation of our success as a democracy, that we could come up with something like that, but now it's suffering from the realities of rule-writing.
The original Glass-Steagall Act (the 1933 law that separated investment banks from commercial banks) was the same act that created federal deposit insurance for banks, and that seems to have been a good thing, because it basically ended bank runs until recently. But you can't do just deposit insurance without also managing the risk, and the activities that banks and financial institutions undertake have become so complicated that that risk assessment becomes very difficult. That seems to be why it's taking such a long time to interpret the Volcker Rule.
Q: We're now some three decades into the 401(k) world, in which most people have to make their own investment decisions for their retirement funds. Are people any more financially literate now than they were in 1982?
A: I would think that it's improved somewhat, but there still seem to be psychological barriers to diversification. It's like at the racetrack — I don't do any betting at all, but I'm told the favorite to show is always the least popular bet, because it's just not an exciting bet.
Q: Given what you know about how investors think and how markets work, how do you manage your personal financial life? You seem like an index-fund guy.
A: Not straight index funds — I do own individual stocks. I don't spend as much time managing my accounts as I probably should. I have a wife and she has opinions, so it's a matter of negotiation between her and me. But I like to diversify, and also diversify internationally.
Q: When you and (Wellesley economics professor) Karl Case developed your house-price index, how did you decide whose name came first?
A: I think we just did it alphabetically. In the academic-economics profession, that's pretty standard. You won't see my name first on many articles.
Q: What do you do in the nonacademic part of your life?
A: I read, especially science magazines. I used to be an astronomy nut, and I still go out at night and look up at the stars and planets — Mars is in opposition now. I get a spiritual uplift by looking up at the sky.
Drew DeSilver: 206-464-3145 or firstname.lastname@example.org