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.

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;