Robert Shiller – The Subprime Solution

1. Introduction

  • Over-promoting homeownership;
  • Effect of financial crisis filtered into other countries, fed back into United States: declining dollars, faltering stock market, more financial failures (IB Bear Stearns);
  • Last crisis, institutional framework changes: new home-loan banking system, private sector reforms (more professional), legislative, insuring banking system, SEC, … become models for similar institutions the world over;
  • Today’s responses, far from enough at least in scale, merely quick fixes that fail to address the full scope of the problem;
  • Short run: prompt and correct bail-outs;
  • Long run: improve financial information infrastructure, extend the scope of financial market to cover wider array of economic risks, provide greater security to customers (create retail financial instruments).

2. Housing in History

  • Home prices “rocket taking off” in the peak of 2006;
  • Different paths, location counts, rate of decline inversely proportional to the speed of increase;
  • Lowest price tier shows biggest boom and drop afterwards.

3. Bubble Trouble

  • Social contagion, epidemics, “new era” stories;
  • Alan Greenspan, acknowledged bubbles, but our models are far too simple; assumes independent rational thinking of individual;
  • Feedback loops, amplified by the news media; price-story-price loop, price-economic activity-price loops; speculative bubbles actually caused by bubbles not fundamentals;
  • Information cascades: disregard their own independent, individually collected information, act instead on general information, squelch their own information, then the quality of group information declines;
  • Rating agencies persisted in giving AAAs, regulators failed to rein in aggressive lending, show no recognition of the boom being the cause of the risks;

America, from its inception, was a speculation.

To a substantial extent, we no longer admired those who were merely hard workers. To be truly revered, one had to be a smart investor as well.

  • Home prices, unlike stock price, move exceptionally smoothly from time to time.

4. The Real Estate Myth

  • Urban patriotism: Californians proud of their pleasant weather and beautiful scenery;
  • Demand for large, walkable urban centers, promote homeownership, restricting new construction is politically fragile.

5. A Bailout by Any Other Name

  • Bailout, Fed offering something unavailable in the marketplace, taking risk by investing in securities that others would not touch;
  • Taxpayers paying for this bailout, tax rebate checks sent to low-income taxpayers, taxpayers paying for the boon of raising loan limits: the losers are disproportionately those people who have prudently been staying out of the housing market bubble;
  • Why necessary: government strive to prevent misfortunes that will create long-standing distrust in economic institutions;
  • Benjamin Friedman: when people see encouraging prospects of the future, they are  better able to work together constructively, supporting democratic principle and political and social liberalization;
  • Systemic effects: financial losses vs. real losses, drop in home values vs. destroy public confidence and the rate of output in the economy falls;
  • Write down the principals of mortgage loans, in the interest of both borrowers and lenders, keep homeowners in place;

6. The Promise of Financial Democracy

  • Fee-only, impartial, useful, comprehensive financial advisers, subsidized by reformed tax policy, especially for low-income people;
  • Designing standard contracts including prudent default option, since people take whatever is offered first or seems conventional; civil law notary;
  • Information disclosure; subsidize creation of enlarged pool of data;
  • New system of unit measurement: UF made Chile the most inflation-aware country in the world; Modigliani-Cohn effect: nominal interest rates were high even though real rates were not; cutting wages in Great Depression; home prices doesn’t basically change over one-hundred years;
  • Derivatives and house futures market: potential to tame speculative bubbles;
  • Other new markets: GDP indexed debts, hedge national economic risks;
  • Continuous-workout mortgages: like regular checkups and preventive care, people pay in advance for the right to bail out, reduce moral hazard by writing into not only borrowers’ income but others’ earning ability;
  • Home equity insurance: prevent homeowners from falling into negative positions, eliminate panic selling, no moral hazard if written on aggregate home value of a city;

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