Shiller on Subprime

Robert J. Shiller of Yale University has been a major force in bringing the vagaries of financial instability to terms we all can understand. His work on stock market booms and crashes is standard reading. 

Today, I was fortunate enough to receive an advance copy of his latest book, The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to do About it. It is a characteristically terrific read and goes into more detail on the narrative highlighted by that wonderful This American Life episode earlier this year. This book is the best short-cut way to get a grip on that crisis.

Shiller provides historical background, not just on mortgage markets but on institutions for financial stability. He also tries to put arguments in familiar terms. For instance, on bailouts, he writes:

In the popular use of the term, a parent who offer a late-night meal to a child who refused to sit down at the family dinner, and is now whining about being hungry, is offering a bailout. …

Let’s return once more to the metaphor of the child who will not eat dinner at the appointed time. Now imagine that there lives in the same house a grandparent who is suffering from a painful disease or is mentally impaired; perhaps one of the child’s parents is in some emotional distress. Having a child throw a tantrum in this situation would be too emotionally draining on the whole household. A wise parent might indeed bail out the unruly child now, and think later about lessons to be learned.

What will be of more interest, of course, is Shiller’s solution. He proposes a raft of measures. Interestingly, much of it is around better disclosure requirements and regulation to protect consumers. But Shiller calls for a new Home Owners’ Loan Corporation to accept mortgages as collateral for loans to mortgage lenders, so long as the terms of the mortgages were acceptable. Sound familiar? It should. Basically, in my reading, he is arguing that the privatised Fannie and Freddie cannot do the job of ensuring liquidity in home mortgage markets and a new government owned and operated entity is required. Thus, despite all that has happened in the US this past year, it looks like they might need an AussieMac too.