Conducted By Thomas Kidd

Robert J. Shiller is the Stanley B. Resor Professor of Economics, Department of Economics and Cowles Foundation for Research in Economics, Yale University, and fellow at the International Center for Finance, Yale School of Management. His book Irrational Exuberance is an analysis and explication of speculative bubbles, with special reference to the stock market and real estate. His newest book is The New Financial Order: Risk in the 21st Century. 

What do you see as the long-term effects of the mortgage crisis? How will the downturn in the housing market effect the U.S. economy on the whole?

It’s a very interesting question. I think I have an unusual view in that I am more worried about it than are most economists. Most economists tend to think of it in terms of a wealth affair. They look at how much the housing market is down. I have data—a Standard and Poor’s price index—which indicates that, nationally, home prices are down 3.5 percent. That is a decline in wealth of about $650 billion, which economists view as relatively small compared to the way the stock market has gone up. I am inclined to think that the housing market decline is more significant than the standard model has predicted because the housing market has a good chance of continuing to decline and, secondly, because the value of housing has gained in significance to households, more so than the stock market.

Also because we have a mortgage problem—a lot of people have already defaulted on their mortgages, and this will only get worse. We are likely to see a lot more foreclosures on mortgages, and this will affect the level of confidence in the market.

Do you anticipate a recovery for the housing market in the near future?

It’s possible. We’ve seen it in some cities—the Boston housing market, for example, has been on the rise since February. But, generally, it’s still declining across the country. I am inclined to think that housing prices have gotten out of line with fundamentals, in terms of income, rent, and the general cost of living.

Also, I think that we had a tremendous boom in home prices. This boom was supported by a fragile psychology. In many U.S. cities there was an unusual burst in the prices of low-priced homes—partly attributed to sub-prime lending—and those prices are coming down still. There could be a turnaround, but my inclination is to think that we had two major booms—the stock market boom of the 1990s and then the housing boom—and both have had major reversals. We have seen an extraordinary psychology supporting the housing market, and that is going to end.

What steps could the Fed the have taken, both in recent months and in the more distant past, to have helped avert the current housing crisis?

They could have spoken out against it. In fact, it used to be that Fred Turner would express opinions about asset pricing. It was Alan Greenspan who created a precedent for silence. He made his famous “irrational exuberance” speech in 1996, but he refrained from any further comments for the next ten years of his reign. Greenspan, since he retired, has given some talks about important phenomena that drive the economy, but he doesn’t think the Fed can’t do much about them. I think they could have leaned against it and spoken out against it more, and it might have reduced its severity. I don’t think of the housing boom as driven by interest rates, as other people do. Interest rates should drive both the stock market and the housing market, but the housing market and the stock market historically have been uncorrelated. It is not interest rates that explain all of this. It is not the Fed’s responsibility.

On a more general note, you wrote in your recent New York Times column that speculative bubbles have become more commonplace in the world. What factors do you believe have been contributing to this trend?

There is a long trend going back hundreds of years. Part of it is our economic development. We have more and more people who are speculating. As the world becomes more capitalistic and we have increasingly global markets, there are more and more people involved. The growing conviction that capitalism is the future of the world has led more and more people to a speculative mentality. I don’t think it’s a bad thing—I think on the whole having better financial markets improves the world’s economies and makes for better social welfare, but it also leads to times of distress.
    
Are economic phenomena such as the housing bubble connected more to personal and group psychology than a nation’s monetary policy?

This is a view that I have held and argued for a number of years. It is at odds with the conventional view. I wrote in a paper in 1981, arguing that there is excess volatility in the stock market not attributable to future dividends or future interest rates. This also corresponds with my view of the world. I have been involved with behavioral economics for years, so human psychology is fundamental to my thinking on these issues. If you look at what psychology tells us about human judgment, it doesn’t encourage a view that everything would be determined mechanically by fundamentals.

In your column, you mentioned that there has been significant decrease in trust in the social safety net, with people shifting their attention from saving to investing. Considering the upcoming presidential election, what role, if any, do think the winner can play in reversing this trend?

There is a question of strategy in terms of getting elected, but let’s talk about what they should do. I think that the rising inequality in the U.S. is a fundamental problem that they have to think about addressing. I don’t think that necessarily gets them elected, however. We have a concentration of wealth developing in this country, and I don’t think it is any anybody’s interest to see that go on, because it ultimately creates social discord. Income inequality was improving in the years after World War II, and I think it led to a better sense of America, a sense that we were a happy people not split by discord. Now it is getting worse, and I think it is creating rifts in society. Part of this is related to social insurance. We still have 40 million people without health insurance, and that is a calamity. It is related to our income inequality, and it is something we should fix.

In your book The New Financial Order you propose the concept of inequality insurance, by which the U.S. government would reframe the progressive income tax system so as to fix the amount of inequality, rather than establishing arbitrary tax brackets. Would you elaborate on this proposal?

This is a proposal I first put in my book in 2003. Now I have a paper with Len Berman, who was Assistant Secretary for Tax Policy Analysis under President Clinton. We have some figures showing how a system would behave using a tax policy simulation model. We found that if we had put in place in the late 1970s an inequality indexation, it would mean the tax system would be much more progressive that it is today. I don’t think we are proposing going back to 1979 levels of inequality, but if we stopped here and put in a system that would automatically raise taxes on the wealthy, there would be just the same percentage chance of becoming wealthy as there is now. In fact, I think ultimately people are more enticed by the idea of high relative income than the idea of high absolute income. It won’t disturb entrepreneurship as much as people think.

Moving on to the global economy, you have mentioned that Brazil remains a hotspot for foreign investment. What factors make Brazil so appealing economically?

I visited Brazil and met a number of people, and I got the feeling that while the country has had discord in the past, under current President Lula they are moving forward with business in a good way. The president has a left-wing ideology and enjoys the support of the country’s poor. He is sympathetic with them, and this leads to a social stability. At the same time, he has shown very practical business sense, believing that Brazil has to move on in business and has to respect private property. This is exactly what Brazil needs to grow. When he talks with Hugo Chavez, he sometimes tries to push Chavez back to more reasonable views. That looks good to me. Brazil has shown very good growth. It’s a part of the developing world that is doing very well.

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