Robert Shiller, Finance And The Good Society

well thank you very much for joining us here today you have a quite a record in calling bubbles and things that went wrong whether it's 2000 or what happened in housing later on and now you've come out with a new book I'm surprised you're still alive called Finance and the good society in which you make the case for all of the things that may have gone wrong and financed the financial industry it performs a vital and essential service and we better not lose sight of it so given what's happened with the stock market in the last 1215 years going nowhere and all of this anti finance industry stuff we hear today from Wall Street occupiers and politicians and everyone else looks like finances hasn't been such disrepute since the 1930s or perhaps since the early 1700s when you have stocks banned in France Mississippi bubble and the like so why the book and tell us what's good about finance well I think that there's always been people saying that financial institutions are important for our modern society but people are starting to think that it isn't true they're starting to think that it's self-interested but I think there is a lot of truth to it and it's fundamental that our society is built around financial institution things that we want to see happen have to be financed and that's the way it works and the financial system allows activities to happen things that will happen not just momentarily but it will go on for years and years and it allows our purposes to be fulfilled that doesn't say that bad things don't happen in the financial world but the basic core is a invention of incredible power and in essence stripping away all of the complicated instruments and the like finance is essentially a middleman taking the resources from those who may have excess resources or on a park it somewhere and putting it in the hands of those who want to put it to work yes we're saying things that I'm trying to put a new color on these so these things have been set Adam Smith said that sort of thing but yes it's true and you know sometimes it creates bad feelings you know I mean but it produced the prosperity that we have today and the world is emerging into the emerging world around everywhere is is developing rapidly and I think it's because of the growth of financial capitalism let me just give you a noted Volcker quote from Paul Volcker and you can respond to what he says I wish someone would give me a shred of evidence that financial innovation has led to growth he's talking about the last quarter of a century more than 80 mg grants that man that's Rises and we get these stories Greg Smith oh the perfidy of a goldman sachs as if those widows and orphans of goldman sachs alliance right and alike how do you respond to that what do you say all right here here's here's where financial innovation that's done a lot of good you just don't realize it well I think you have to start looking at the mechanism I don't know what people want as proof that financial innovation has helped economic growth how would you prove that we've had you know we could do a controlled experiment that would cut off some country from finance completely and I bet they would go down the tubes as a result Greece may find out yeah but we can't do that and so if it's one of those things that is hard to prove but I think we can make a pretty solid case for it well you cite some very basic things fire insurance the mortgage where you pay down a little bit instead of the old one we every five years you hope you get a renewal oh you had self-advertising mortgages other quick examples come to mind that people take for granted they don't realize it came out of well I like to give you know Paul Volcker said that the only innovation he could think of that he liked was the ATM machine that was just two years ago when he said that so I like to give examples of intimate innovation that's happened since he said that well and one of them it's kind of interesting is the the new crowdfunding that the US Congress created with the JOBS Act this will allow something like the Wikipedia phenomenon to be extended to actual investing so it's it's adapting the internet technology to kind of bring more people into venture capital it's an experiment it may not work but I think it's an interesting experiment and it illustrates one of the principles I talked about in the book which is the democratization of Finance over the centuries by democratization I mean bringing more and more people in over the centuries financial institutions which were very small and rare have become a bigger and bigger part of everyone's lives and I think this is the kind of progress that innovation can make happen and that we want to see continued to happen well two other examples way before ATMs but very relevant mutual funds right put in a handful of dollars in the playfun get-get-get shares or money funds breaking down an old depression price controls and interest rates now you too could get a market interest rate when we had market interest rates yeah I think well I've written a book with lots of example that's one that comes particularly to mine to me is the invention of stock markets that is a very important invention because what it does is allows people to take part in a business enterprise to whatever extent they want however many shares you want and it allows you to reward people by offering them shares in an enterprise and you can scale it up or down as much as you want and then there's a price which is observed every day not always rational the price can be crazy sometimes but the the mere presence of this institution I think has been a huge driver for economic growth I don't know the exact numbers but if you compare price earnings ratios of a firm that would have been sold 150 years ago or even years ago compared to what you'd get precisely because you have a stock market and open price information it's almost exponential two or three times what you would have had in the old days well the since the stock markets were created we have seen enormous returns on stock on average over over time so something they're doing right and not and not sure how to explain that let's quickly hit and then we'll discuss the the crisis itself some of the things they throw against markets derivatives what do you what do what do you say about derivatives well derivatives are exposures to risks that are well-defined allowing people to hedge the risk that you might be too exposed like I've advocated a derivative market for home prices so that we actually created one at the Chicago Mercantile Exchange homeowners can now if they feel that they're overexposed to real estate risk they can hedge that by by shorting the real estate market and if they're underexposed Goldman Sachs doesn't have to invent an instrument for a paulson anymore for you – yes now that's right so Paulson managed to short the housing market only indirectly but now well he had to do that we had our market in place but I think it was too small for him but as these things grow people people will be able to take positions now some of them will make billions for doing that but I think that's that's what happens when you create a game that not a game it's the game of life you know for for everyone and I think it's unbalanced a good thing very much a good thing for our society millisecond trading flash crash you have an interesting thing to say about that nefarious instrument called The Telegraph I that's right well modern information technology is really changing the world and it's speeding things up it's created some people who necessarily specialize in what we call millisecond trading which is using computers to trade and they can get ahead of you in line because they have a computer that which is faster than you'll ever be so there's some concern about it but I you know I don't think that it's there's anything damaging now we may there may be some reason to regulate them but I don't see it at the moment and I note that on your Forbes 400 list I don't think tell me if I'm wrong there isn't any millisecond trader on the list who made it through millisecond trading so I don't view them as as important I think it's kind of a good story it's a little bit like you know now we have computers and so we do things with computers and so some things happen really fast now that's all it is I don't I don't think it's something to worry about just the speed is more like Telegraph suddenly instead of mostly sending pigeons you had it in an instant yeah it's neither really amazingly good or amazingly bad it's just an implication of information technology and I think we're going to see a lot more implications develop as time goes I mentioned crowdfunding as another innovation as information technology is expanded it's breathtaking I think to think about what will happen in our children's lifetime as information technology expands along with the application of financial theory and you touched on it just barely front-running what do you say to people well that means they're gonna get a better price than I'm gonna get well front-running is I think unethical behavior that brokers implicitly promise not to do when you tell your broker I'm going to buy you know a large number of shares of stock and and he's operating as a broker and not a dealer he should stay in that capacity and not buy on his own account ahead of you and take some of the money from you so that is a matter of ethics now I suppose your broker can tell you I'm not trustworthy you tell me anything and I'll use it for myself as long as he discloses that and if you want still to deal with him then I suppose there's nothing unethical but but business ethics are a central part of the functioning of financial capitalism and people have to live up to what they've told you they will do and front-running doesn't fit that mold right now you mentioned the book that in terms of Finance being an ill repute it's sort of always had an odor for several thousand years but it seems that really comes into sharp focus when there's been a financial crisis why did we have this financial crisis was some inherent flaw in free markets or were there other factors at work that just turned the nearly ran the system off the rails I wouldn't call it a inherent flaw in free markets I would say it's a flaw in the systems that we had in place and institutions we've had in history had to reinvent our markets and our financial institutions it's it's not just the government it's the private sector and the government that has to change their thinking in response to accidents this was an accident it happened because of some misunderstandings about there were bubbles that that grew and burst and those things happen we which in my book though I say bubbles are not inherently a financial market phenomenon they occur even when there are no financial markets so I give in my example of speculative bubbles the the great leap forward that Chairman Mao created if there had been ability to short the great leap forward and if there had been analysts publishing their interpretations of Chairman Mao's for prescriptions that would have lessened the impact of that bubble on Chinese society so the idea of financial markets is yes people are fetish they can go off on a tangent for a long time but the best way to deal with that is to have a free access to markets and they have somebody if who can freely and analyze the prices that are developing in the markets and then take hedging steps to prevent a disaster so the fundamental problem isn't free markets the fundamental problem is the existing institutions and the existing models that people had that have to be fixed fixed and improved and that's progress will do that what do you think we're the models that went wrong well one thing that this I could go on a great length about this but what comes to my mind first is that we had a efficient markets theory that was thought to be a reason to trust market prices in excess people thought that markets can never be wrong that you can't beat the market just swim with the tide because the market is smarter than anyone I know you don't believe this having read Forbes magazine magazine I know that it it pays to think about what's going on and there another thing that developed was kind of a excessive respect for mathematical statistical models that we thought we had experts who had programmed everything and figured out everything and we had Value at Risk and other methods of analyzing but though but ultimately those methods are only as good as the people who use them we kind of forgot about people we should never forget that it's always people who are behind the stitute doesn't that argue a little bit against financial instruments where you you say here in fact that we had hubris in managing risk and risk therefore no risk therefore I can go leverage up a hundred to one cuz I've precisely done it in a way where I've yeah minimize the risk well hubris is a human failing that is concerning that I don't know what to do about it though one thought is that we but one thought which Louis Brandeis said the Supreme Court justice sunshine is the best disinfectant so as long as we require people to disclose what they're doing and be honest about what they're doing as long as we have analysts who are doing their job in an honest way and are not you know in cahoots with somebody these things get revealed and the hubris that some people show is exposed and that's what a democratic system and financial capitalism properly designed can achieve now what role and I know this is not taught in schools anymore but could we've had this disaster if the Fed hadn't cheapened the dollar so much after all in the 70s we had a commodity boom we had a housing boom oh yes right and so if they had done their job could this thing have reached the size that it did it they and the other central banks weren't pumping out excess money right well that was definitely a factor the interest rates hit zero practically while the housing boom was going on in the early 2000s so I don't know how to estimate exactly how important that factor was but you know when you have really big historic events it's probably a combination of factors and that was one of them in terms of fixing the housing market we've talked about pre plan workouts where something goes wrong in the mortgage it automatically goes down what are your thoughts about going back to once made mortgages what they once were prime credits because you put 20% down with a 20 year payout you couldn't get more than four or five times your income right they worked right it's kind of remarkable historically that it used to be if you go back before the Great Depression it was even more than 20% I think they they would often ask for fifty percent down to buy a house and so somehow the loan-to-value ratio just crept up and up and it was part of a complacency that developed over all these years but I've done that now the question is is there some systemic problem that led to that one of those problems that may have encouraged it is that we created government institutions Fannie Mae and Freddie Mac and FHA that gave implicit government support to these mortgages that might have previously been considered too risky to issue and that's part of the problem it's also partly just the the complacency that we got this is independent of the government from having no repeat of the Great Depression for a better part of a century do you think FHA's is a still on pop bubble FHA worries me the FHA it claims that it's okay murmur I've seen that movie before but I've seen you know Joseph jerko at the Wharton School has a paper pointing out that they are arguing that the FHA is in a vulnerable position having is seen the housing market declined so much and having so many under underwater mortgages so I I'm inclined to worry about the FHA and right now a lot of people are hoping that everything will be fine because home prices have started moving up again and they could just get off scot-free if they just have a huge rally in the housing market that might happen so FHA might be just fine but I tend to be a worrisome and I tend to think that it it it may be much longer in coming this rally in the housing market and it won't be enough to bail them out would have been better for the government once the disaster hit to let disease to say let the markets clear and people say my gosh I've never seen prices like this and never see him again better get in you saw a little bit of that in Phoenix in Las Vegas before the fall of 2008 people are starting to nibble again yeah yeah Phoenix is what's going up right now rapidly and yet markets are inscrutable I don't understand what happens and why these booms happen or where they are as for letting the letting the chips fall where they may I'm just not I don't have the nerve to do that if I were a Fed Chairman I would have done something like Bernanke because I just I don't know what no not so much in the panic of September 1 yeah the system almost did get cardiac arrest yeah but in all the government programs since then trying to help housing and end up not doing very much good for housing well I tend to be sympathetic to people who got caught in this mess and unemployed and they've losing their house now my idea is that we should do something for them something constructive but let's make it happens so that the government doesn't need to get involved the next time so we should rethink our mortgage institutions and I've argued that that for pre-planned workouts that would be not paid for by the government that would be priced into the original mortgages so that people don't they don't have to have this problem again and that to me that's that's the epitome of financial capitalism you see if a crisis like this and you say how can we as private citizens workaround so that this doesn't happen we don't want it to happen again and my proposal for free plan workouts doesn't even require the government it probably will involve the government as facilitator but it doesn't necessarily have to be that way well this gets to dodd-frank which you pointed out previously whatever one thinks of the need for reform this has got what 50 studies there are many new bureaucracies yeah this is gonna hurt innovation I mean one bank kid told me he had to hire a thousand extra people for compliance yeah how does that help innovation well we have to get the right balance of right we don't want right you know I've tried to innovate I know exactly what he's taught a company I still have it that that tried financial innovation and we had to go through regulatory approval and it slowed us down on the other hand I think regulators are important that if we didn't have them we would have fraud and corruption and abuse of things that there's a difference between rules of the road that say don't go above 60 or 70 or whatever right and telling you what car to drive and it's not either crushing regulation or anarchy or something where you can innovate right well I agree I agree with you that we need financial innovation my impression is that I actually have a favorable impression I mean you're probably of a different impression of regulators than I do that I think that they're well-meaning people who are trying to make the system work they're limited often by bureaucratic structures it's government right and you can't just give free rein to your imagination but I think I'm probably warmer to regulators than you are well the not to belabor the point but you've made the point in terms of history that you have to update the rules the road for example when they try to take over the Erie Railroad that great fight after the Civil War and Google would issue stock at midnight no you cannot do that anymore right sensible rules of the road still allow for plenty of innovation well dodd-frank is an awfully long bill and it does raise concerns but I'm actually sympathetic to that bill because it did try to confront the the the house of cards collapsed that we saw and and it wants to prevent the preamble to dodd-frank says let's prevent taxpayer bailouts that it's the too big to fail problem that we want to deal with and as long as we think some companies have to be bailed out if it to save the economy we'd better prevent that from happening again so I thought the dodd-frank bill was a nice try we'll see how it works in practice it's too soon to tell but we it's a complex system and that bill is complex and I'm sure many parts of it will have to be changed later you've talked about the need for financial advice for everyone do you foresee the possibility of in terms of financial advice of variation of jpg and any who found it what became Bank of America serving communities ie those days immigrants and merchant seamen that traditional banks wouldn't touch do you see ferments of innovation of people figuring out how do you how do you get these unserved markets and doing in effect what gene and he did and create a new kind of institution and traditional industry well it's it is happening I think right now I don't know exactly all the things that have been happening but for example there are some private organizations that are dealing now with Mortgage Advice it isn't just that the the dodd-frank Act created an office of mortgage counseling but that's small I think there's lots of things going on of people who are changing the way the mortgage industry is is happening there are also lots of financial advisors I think that's changing all the time the there are these fee-only advisors who express commitment to their clients I think that movement has been growing we we see a lot of little innovations in financial services that I do think are bringing us better toward good financial advice more readily available quickly your index versus the median price prices we hear in housing what's the advantage of your index in terms of getting a real understanding what's happening and what still is a very fragmented market well repeat sale index infers home price changes from changes in prices and individual homes and it deals with a problem that plagued the median namely that you know sometimes people put a lot of big houses on the market and it pushes up the price temporarily if you look at the simple median uncorrected of home prices it tends to be noisy and jump around so we my colleague Carl case and I first published an ongoing we were the first to create a ongoing repeat sale price index and people were stunned to see how it looks it's not as noisy or choppy as you might have thought by looking at medians it's a more stable and trendy series than it ever been realized I think we got to a better understanding of these markets and finally stocks you certainly called couple of big markets but tell us the story about arguing with your spouse and not getting too caught up in trying to time the market okay well back yeah I'm not sure which story you're asking about but in yeah in 1996 I testified before or the Federal Reserve Board with Alan Greenspan and I got I was trying to urge on Greenspan and the board that the market was going through a bubble in 1996 this is well before the peak in the market and he gave a speech called the irrational way he used the term irrational existence and the markets all over the world dropped on on his words of and so I this is where I got into I told my wife I know it's story you're asking on the morning after his feet I told my wife you know I might have caused a worldwide stock market crash because I talked to Greenspan and then Greenspan gave a speech and that I told Greenspan I thought the market was overpriced Greenspan gave a speech and then immediately the world stock markets dropped so my wife told me you're crazy Bob you couldn't have done that but then when she saw how much talk and consternation followed his speech he said well possibly you're right she put it in our Christmas letter for her that we mailed out it with our Christmas cards Bob caused an international stock market crash I don't think I did I don't think we know that Greenspan did the home because the markets are vulnerable when someone says something they moved something as frivolous as the words irrational exuberance and that that brings me back to one of the themes of this book the crazy things that sometimes happen in financial markets lead some people to doubt the value of the whole concept of the financial sector but the theme of my book is that crazy things happen with people and the financial markets reveal they tell you the ugly truth you see the price movements everybody knows what happened how big it was and then we learn from this experience and then we have experts who have seen and know these data so the next time around we're not as crazy so I think that the the financial markets and the instant all the professional organizer Asians and all the experts and the people are dealing with difficult problems and they're dealing with them in a much more sensible way than we would have with any other any other economic institution so getting mad at finance is like shooting the messenger that's right that's that's a very nice way of putting it Bob thank you very much the book is finance and the good Society

  1. Could Mr. Forbes please interview Bill Ackman, Steve Schwartzman, and Kyle Bass.  The best interviews so far have been Ron Baron (both interviews), Monish Pabrai, and John Linehan from T Rowe Price.  Good job keep up the good work!

  2. I really like Shiller, but one should not forget to watch him closely. I think he is a naive guy, unattached to the normal life of ordinary people. He is emphasizing the positive impact of financial capitalism, but especially in the past decades we had not more growth – although, as he points out himself, we have the revolutionary information technology. Instead we had the biggest crisis and normal people are earning less and less while the rich earn more and more while getting more power.

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