"Irrational Exuberance" Author Explains Real Estate Crisis And How to Avoid Another

If the current real estate crisis is to be resolved and a recurrence prevented, there need to be major changes both in the marketplace and in the behavior of individual investors, explains Yale economist Robert J. Shiller in his new book, The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It.

In this work, aimed at a general audience, Shiller explores the subprime mortgage crisis from its development in the early 2000s to the threat it now poses to financial markets around the world. He cites both economic and social factors as contributory causes of the crisis, and offers a list of possible solutions to the problem.

In his best-selling book, Irrational Exuberance (2000), Shiller, the Arthur M. Okun Professor of Economics, examined speculative bubbles in the stock and housing markets. Now expanding on that analysis, The Subprime Solution demonstrates how the recent economic boom and increased speculative thinking in the United States real estate market led to an epidemic of risky investing and false security. This, in turn, helped to bring about the current economic downturn, says Shiller. Understanding the reason for the decline, he argues, might be the key to restoring and maintaining market stability.

“It is time to recognize what has been happening and to take fundamental steps to restructure the institutional foundations of the housing and financial economy,” declares Shiller, who advocates an aggressive response to the current dilemma. The short- and long-range plans he recommends are aimed to end the present financial crisis quickly while also preventing another one from occurring.

Shiller draws a connection between social behavior and financial decision-making, and underlines their mutual influence over each other. Accordingly, he places as much responsibility for the subprime situation on human behavior as on market forces. “It is the change in thinking about ourselves that is the deepest cause of the bubble and may be the slowest to unravel,” contends Shiller.

The Yale economist’s proposals for overcoming the current crisis range from government-funded bailouts for the least advantaged members of society to the creation of more planned urban centers to the establishment of a new organization modeled after the New Deal-era Home Owners Loan Corporation (HOLC). All of these proposals, Shiller asserts, would help restore what he terms “rightly placed” confidence in the market.

Shiller also argues for the creation of a new information infrastructure to teach people how the market operates while encouraging them to borrow, save and spend responsibly. Such a program could be the key to preventing new crises, he reasons. Other proposals he puts forth include a new system of economic units of measurements to ensure standardization across the market, the establishment of a new liquid market for real estate, and home equity- and livelihood-insurance.

Robert J. Shiller is a member of the Cowles Foundation for Research in Economics at Yale and professor of finance at the International Center for Finance at the Yale School of Management. He specializes in the fields of macroeconomics and finance, behavioral economics and real estate.

The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It has been released by Princeton University Press.