On Shiller


A general bonfire is so great a necessity that unless we can make of it an orderly and good tempered affair in which no serious injustice is done to anyone, it will, when it comes at last, grow into a conflagaration that may destroy much else as well. 

John Maynard Keynes, “The economic consequences of the peace”, 1919

So begins Robert Shiller´s new book, The Subprime Solution. If Soros explained the problem well in his book, Shiller does a good job of explaining what a solution may look like.

The short-term solution to the current conflagaration is a bailout, as Paulson is proposing. A new RTC or HOLC will go some way is solving the current loss of confidence in the US financial system.

The long-term solution that Shiller proposes is nothing short of a complete restructuring of the mortgage & financial system as they exist now. He proposes a six-step plan. I slept off during the first four steps, but the last two steps are interesting.  They are:

1) Create large national databases of fine-grained data about individual financial situations.

2) Create new economic units of measurement.

While the database will be useful for better credit rating, The last step is the truly brilliant one. What Shiller suggests is  “Index everything”:

-Index house prices and rents to inflation

-Index mortgage payments to the financial situation of the borrower

-Index government borrowing to the current GDP and so on.

Any kind of indexing that makes you pay more during the good times, so you can pay less during the bad times is a form of insurance. Shiller believes that the best way to save the US economy from future accidents is to have inbuilt insurance within the system.

For the home-buyer, this works in two ways. Since salaries and house prices are indexed to inflation, he knows when house prices are too high relative to his salary. When he does take out a mortgage, it is a continuous workout mortgage, whose payments change every month based on his current financial situation.

For the government, it becomes easier to borrow in trills, or bonds that pay out one-trillionth of the GDP per year. During a boom, this goes up, during a recession, this comes down. That way, you get the Chinese and the Arabs to fund your economy and insure it at the same time.

He also recommends, like Friedman would have, that the problem is not excessive innovation, but too little. At this difficult time, we need to develop futures on real estate, possibly using his Case-Shiller Index, so anyone who thinks a boom has gone too far can sell the futures. This will also help the construction industry with a good idea of what real estate prices in the future would look like, and they wont construct all these houses that wont sell.   Finally, someone speaks up for short-sellers!

While the solution is brilliant, I expect zero political will to implement it. Alan Greenspan once said, “If you are unwilling to accept booms and busts in economics, you need to accept a lower standard of living”. If you think of the average disposable income in the US, and its volatility, Shiller´s plan to essentially reduce that volatility by giving up some income as a insurance premium.

Obama will not consider freeing up the financial markets further, and McCain will not consider insurance. Unfortunately, Shiller´s long term solution, involving both freer financial markets and built-in insurance, will never be considered.

0 comments… add one

Leave a Comment