Shiller's Rapid Response to the Subprime Crisis
By Arnold Kling
Robert Shiller has a new book, The Subprime Solution, due out in three weeks. [UPDATE: if you can’t wait for the book, you can go to Mark Thoma is showing a Youtube.] The publication process has gone incredibly quickly. Obviously, he does not cover the Fannie-Freddie debacle, but he does manage to comment (disparagingly) on Paul Kruman’s May 12 column, in which Krugman dismissed the possibility of a speculative bubble in oil. On p. 63, Shiller writes,
the price of oil is, just as the price of housing, inherently and deeply speculative.
Incidentally, Robert Murphy has more on the oil speculation elsewhere on our econlib site.
If the publication process of Shiller’s book is surprisingly rapid, the quality of the contents is even more striking. If I were to quote every interesting passage, I would end up posting thousands of words. Instead, I’ll attempt a quick summary.1. The main cause of the subprime crisis was a housing bubble. This was primarily a land bubble. On p, 64:
It used to be that the underlying land typically constituted only 15% or so of the value of a home in a typical city…now that land value…is often over 50% of home value
If house prices were determined by construction costs, then you would not have a bubble, because prices would depend on supply and demand of factors of production. But when house values consist mostly of land, then the price today depends very much on the price you expect tomorrow. We have had plenty of land bubbles in the past, and we probably will in the future. Shiller displays on a graph the simultaneous land bubbles in Boston and London.
One can tell that Shiller finds land price inflation offensive. He points out (p. 73) that urban land area is only 2.6 percent of all U.S. land, and he questions the scarcity. He thinks that developers can lobby to overcome land use restrictions, so he does not think that regulations provide a long-term explanation.
He thinks that with better urban planning, we could create cities that could compete with New York or Los Angeles. Obviously, he is not a Jane Jacobs disciple. This was the part of Shiller’s book I found hardest to swallow.
Given these views, it is not surprising that Shiller is opposed to any public policy whose main objective is to sustain home prices. He thinks that lower home prices are a good thing. I am with him there.
2. But we do need bailouts, in Shiller’s view. Shiller does see falling home prices as causing lots of people to suffer, particularly low-income and middle-income owners who took out large mortgage loans recently. He is worried that if they are not helped, then resentment will build and we will be like Europe in the 1930’s, filled with hatred and distrust. On p. 96, he writes,
In good times people are willing to cooperate and accomodate others, but when optimism for the future starts to sour, they can become introverted, angry, fearful, and selfish.
He says that the New Deal served to maintain community spirit in the 1930’s, and we need something similar today. In other words, if we take a new dose of collectivist medicine, we’ll all feel better in the morning. If not, we might lose our ability to trust and co-operate with one another.
3. Long term, we need to make better use of financial innovation and information. Some of his ideas are recycled from his previous books. One idea that is new (I think) is to create a new entitlement to financial advice. On p. 125
subsidize fee-only, comprehensive, independent financial advice for everyone
He draws an analogy between financial advice and Medicaid and Medicare. I think the better analogy would be between financial advice and nutritional advice. I’m not sure I want to subsidize giving people advice if they are not going to follow it. And I worry that trying to stop people from chasing financial mirages is like trying to get them to eat their vegetables.
I’ve mostly emphasized stuff with which I disagree. There is also a lot with which I agree. It’s a very stimulating book. I recommend it highly.